Tax Loopholes Are Good

Laffer_CurveTwo recent Mises Daily articles have touched on the issue of tax credits and tax advantages for certain industries, such as the film industry and other industries seeking tax credits and tax advantages at the local level as part of a local “economic development” strategy.

Many left liberals refer to tax credits and available tax deductions as “subsidies,” usually with the intent of having these tax “loopholes” eliminated and tax revenue increased. For this reason, I avoid running articles that refer to these sorts of tax credits and deductions as “subsidies” because they confuse something that reduces government revenue with out-and-out government spending. One can debate the semantics of the matter, but subsidies in my view are actual tax outlays for a specific group or industry. Tax credits and tax deductions, on the other hand, are essentially tax cuts that are good for two reasons: (1) They reduce tax revenue, and (2) they reduce the tax burden on at least some people.

Now a reduction on the tax burden for, say, homeowners through the home interest deduction, provides an arguably unfair advantage to homeowners and people involved in the business of building and selling homes. On the other hand, the elimination of this deduction would mean an enormous increase in tax revenue for the state and a huge increase in the tax burden for millions of people. It is indeed true that tax loopholes of this sort to cause malinvestment, they distort the economy (although it was already distorted by the tax in the first place), and are a case of the state choosing winners and losers. The answer to this, however, is to not reward the government with more revenue by eliminating the loophole. The answer to these tax loopholes, then, is not to eliminate them, but to create similar loopholes for others. In this case, rental housing should enjoy similar loopholes through which renters can see tax reductions as well and not be incentivized to buy homes. In other words, the free-market answer to tax loopholes is to create even more tax loopholes.

The opposite position leads to all sorts of mischief, as discussed by Bob Murphy here, Tom Dilorenzo here, and Murray Rothbard here. In the Rothbard article, he provides  a short history of the tax-credit-as-subsidy line that conservatives bought into after 1986:

Since voicing the idea that perhaps it is not the government’s place to go around Solving Social Problems had subjected them to the withering charge of “insensitivity” and “lack of compassion,” some conservatives latched onto a shrewd end-run strategy. ”Yes, yes,” they agreed, “we too are convinced of the urgency of your Social Crisis, and we thank you for calling it to our attention. But we believe that the way to solve the problem is not through increased government spending and higher taxes, but by allowing private persons and groups to spend money solving the problem, to be financed by tax credits.”

In short, the social crisis would be solved by allowing people to keep more of their own money, provided they spend it on: aiding hangnail research, BMWs, or combating beri-beri. While the fundamental philosophical problem was sidestepped, at least people were allowed to spend their money themselves, and taxes would fall instead of increase. It is true that people were still not being allowed to keep their money, period, but at least the tax credit was a welcome step away from government and toward private action and operation.

In 1986, however, everything changed. Conservatives joined liberals in scorning the tax credit as a “subsidy” (as if allowing people to spend their own money is the same thing as giving them some of other people’s money!) and in rejecting the tax credit approach as a “loophole,” a breach in the noble ideal of a monolithic uniformity of taxation. Instead of trying to get people’s taxes as low as possible, reducing taxes where they could, conservatives now adopted the ideal of a monolithic, “fair,” imposition of an equal pain on everyone in society.

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