Mayor Bloomberg recently proposed limiting the size of soft drink containers in his fight against obesity in New York City. Not surprisingly, Hizzoner’s suggestion elicited pointed complaints about unwarranted governmental intrusion into the inalienable rights of citizens. This, claimed some, was the arrogance of the nanny state. As the debate gathered steam, a public radio station aired a program in which the moderator suggested an alternative means to achieve the mayor’s well-intentioned goals without all the muss and fuss: Why not use tax incentives rather than outright restrictions? Fat people, however one might define them, would receive a tax credit for the pounds they lost over the taxable year.
Other participants in the radio panel cited problems with definitions, measurement and implementation, but not one of them criticized the principle of using tax credits as a means of social behavior modification. This is not surprising. We have been using tax subsidies and penalties, all attuned to the Internal Revenue Code, to achieve public goods (and some not-so-public goods, too) for so long that it strikes most Americans as something integral to the founding documents of the Republic itself.
We have been using this method, too, over a very wide range of public policy issues. Congress has determined tax credits and other tax subsidies for housing policy (the home mortgage interest deduction and low-income housing credits, among others), employment policy (the new markets tax credit), business (accelerated depreciation of equipment and machinery, and the deferential treatment of capital gains), energy policy (wind power, solar power, building conservation and retrofitting, and more), agriculture (the Iowa beginning farmer tax credit), philanthropy (the charitable deductions credits), historic preservation (the Federal historic rehabilitation tax credit) and family policy (an adoption credit). This hardly exhausts the list.
Indeed, so ubiquitous has the method of using tax policy to operationalize social and economic policy aims become that it now amounts to the default option for getting anything done. It rarely if ever occurs to us to ask, first, whether this method actually works very well compared to others, and second, why and how we got ourselves into this habit in the first place. To answer such questions, we need to dig up a little history.
he beginning of wisdom here is to remember that Federal income tax laws were instituted for a traditional and simple purpose: to create a revenue stream to operate the government. The first income tax was levied to pay for the costs of fighting the Civil War and lapsed after the war’s end. Attempts to recreate it faced Supreme Court determinations that an income tax was unconstitutional. It took a constitutional amendment in 1913, the 16th, to change this, and the motive for this amendment was all bound up in the temperance movement. The Federal government had funded itself after the Civil War on excise taxes, not least of which was a tax on alcohol. Banning alcohol meant undermining the fiscal stability of the Federal government. Hence the Sixteenth Amendment and the Eighteenth Amendment (prohibition) formed a logical pair. Some argued in the 1920s and 1930s that therefore to repeal one implied repealing the other. Logical, yes, but it didn’t happen: Prohibition is long gone since 1933 (the Nineteenth Amendment), but the income tax abideth, apparently, forever.
Originally, the income tax applied to a very small percentage of Americans. It was not until the World War II era that it became as nearly universal as it is today. But the tax provided a steady, adjustable and alluring pot of money for a Federal government whose purview was expanding both because of ideology (Progressivism) and need (Depression and war). That alone does not explain, however, how we get from enhanced revenue stream through taxation to the use of tax policy for purposes of social engineering.
Dean Erwin Griswold told the class of 1956 at Harvard Law School that this issue had been decided in the early 1930s, when Al Capone was convicted of income tax evasion. The government, he told us, had exhausted all other efforts to convict Capone when someone came up with the idea of looking at the Internal Revenue Code in order to nail him. There they found the answer: tax evasion. That, according to Griswold, was the turning point that installed the Code as a tool of social policy. To some of my classmates, the dean’s statement may have seemed a bit of a stretch. But was it really? Nailing Capone for tax evasion wasn’t just a matter of finding the most expedient way to send a hardened criminal to prison; the high-profile conviction was also a deterrent for any hoodlum (or ordinary person) considering similar violations of the tax code. From there, it does not take much of an inspirational leap to recognize that you can use that same code to discourage (or encourage, for that matter) almost any behavior you want.
o it came to be. But is this wrong? It cannot be denied that tax incentives and subsidies have gotten a great many things done that wouldn’t otherwise have been politically feasible: millions of units of low-income housing, vastly expanded mineral exploration, the building of modern aircraft, and the development and restoration of historic properties, for instance. It also has allowed a useful if limited convergence of conservative and liberal thinking. For conservatives, tax credits look, feel and can be spun to seem like a tax cut; that is inherently good. For liberals, they can advance such ends as environmental preservation, so it just has to be virtuous.
The historic preservation tax credit provides an excellent case in point. Basically, the way it works is that investors put up money to restore an historic property. In return, they get a credit against their income taxes that can be as much as 20 percent of the restoration costs. So, if these costs are, say, $10 million, you can get a credit against your taxes for as much as $2 million. Before thinking that this is the ultimate free lunch, keep in mind that the $2 million credit represents $2 million of tax revenues forgone by the government.
This being the case, why use the Code to subsidize the preservation of historic properties, or anything else for that matter? Why doesn’t the government simply collect the taxes and apply the money directly to these properties? A major reason for the use of these incentives has to do with transparency, or rather, the deliberate lack thereof.
We have recently embraced the concept of transparency the way teenagers embrace sex—except when it comes to tax policy. The very lack of transparency is why this policy can be so effective in getting programs implemented that might not otherwise see the light of day. If Senators, Congressmen and Presidents tried to allocate tax revenues openly in the Federal budget to the policies now supported by tax subsidies, they would likely find their re-elections in jeopardy. Tax subsidies hidden amid thousands of pages of indecipherable legislation and tax code regulations provide a perfect example of how collective action often plays out. The relatively few people who care about a given subject will pay close attention to it, while the vast majority will approach the same subject with justifiably rational ignorance. The less easily accessible information there is, the better the process works.
Many years ago Senator Everett Dirksen commented on the Federal budget, “A million here, a million there, and pretty soon you’re talking real money.” In the case of tax subsidies, these days we are talking about $100 billion here and $100 billion there, which really does add up to real money. Given our concern these days with deficits, how would your Congressman feel about defending these subsidies to you and his or her other constituents? They may want the programs promoted through tax subsidies, but, very often, only if they can conceal the actual expenditures. These tax subsidies so assiduously courted not only increase the deficit; they are, in great part, the deficit itself.
As already suggested, tax subsidies can be very effective in getting a worthy job done. But that does not answer the basic question: Is the Code the proper or most effective place in a representative democracy through which to get these things accomplished?
Everyone has his favorite project, program or policy, and that applies to liberals, conservatives, radicals and reactionaries alike. Everyone should be clear as to what this means: If the Code is to continue to be used to push these pet projects through, then we should stop talking about tax reform. Whatever the rhetoric, the Code will get longer, more complex and less transparent so long as we use tax credits to shove around the public policy agenda. And, frankly, we citizens will have ever less control over what is spent.
For these fairly basic reasons alone, the Code should return to its original purpose of collecting revenues. If someone has a worthwhile program, it should be openly proposed and appropriated, with the actual price tag attached. This not only means transparency. It also means simplicity. I defy anyone advocating tax credits, for example, to file a tax return without having it prepared by a tax attorney or accountant.
If the Code were revamped to eliminate tax subsidies, credits, preferences and all the rest of the lawyerly obfuscations with which it is now festooned, we could come closer to a tax on gross income, with deductions being very limited. Such a tax would be politically feasible and even welcomed if it meant lower tax rates, as well it might. Ask yourself this: If a gross income tax were accompanied by a top marginal rate of about 15 to 20 percent, would you spend much time and money to avoid paying this tax? When you answer this question, include savings on lawyers and accountants as part of your calculation. Most people would jump at the chance to avail themselves of this option.
hat would happen if we strip the Code of subsidies and go to a gross income tax? The first question is, what constitutes gross income? It could be the same as it is defined in the current Code but with no adjustments for exemptions or deductions or credits that reduce gross income.
Eliminating exemptions and deductions for individuals can be an incendiary issue. So it might be useful, I once thought, to be flexibly selective about this. We could still allow homeowners a deduction for mortgage interest, at least up to a reasonable ceiling. But what should that ceiling be? Should it depend upon whether you are rich or poor, married or single, with or without children, or in a heterosexual or same sex marriage? And, in the interest of fairness, if homeowners get a right to deduct interest, how about rent deductions for tenants, especially low- and medium-income tenants? It soon dawned on me that allowing exceptions and flexibility amounts to rebuilding the Code by making all sorts of judgments on social policy. This won’t work: Once we start making exceptions, we quickly slide toward the bottom of a slippery slope.
So each of us will have to give up the cherished tax benefits we’ve grown used to. Does that make the whole idea politically impossible? Not necessarily. Several years ago a colleague noted that there are very few problems in life that can’t be solved by more money, which translates rather easily in this case to significantly lower tax rates.
We as a nation can do this. It only takes leadership prepared to buck the tide of plutocracy. Remember that the next time you hear anyone suggest a tax credit to do what the normal protocols of a representative democracy should do. Tax credits help some people, even to do good things. But they are a deceptively expensive way to run a government. If we are serious about getting Federal spending under control, and about tax reform as part of that process, we are eventually going to have to face head-on not just the plague of tax credits, but also their use as a matter of basic principle. We debate this and that credit all the time, but the principle virtually never. That is what we need to discuss.