Wednesday, August 10, 2011

What the Tea Party Gets Wrong

Suppose the government wants, for some reason, to subsidize biofuels. There are at least three different ways to do it:

1. For every gallon of biofuel produced, the government will pay the producer a one dollar subsidy.

2. For every gallon of biofuel produced, the government  gives the producer a one dollar tax credit.

3. Make a regulatory rule that forces people to use more biofuels, such as a requirement that gasoline can only be sold if combined with at least ten percent biofuel.

The first two differ only in labeling. They have the same effect on the federal budget. They provide the same amount of subsidy. They are both, in fact if not in form, federal expenditures. The only difference is that the second is an expenditure masquerading as a tax cut.

A lot of expenditures pretend to be tax cuts. If you look at the CBO figures for federal income tax in 2007, you discover that, on average, the bottom 40% of the income distribution not only does not pay federal income tax, it is paid federal income tax—a federal welfare program in the form of tax credits. And since these are 2007 figures, it is Bush's federal welfare program, not Obama's.

As best I can tell by news stories dealing with recent budget controversies, this simple point has somehow been missed by the Tea Party Republicans. They insist on taking such expenditures at face value, as tax cuts rather than expenditures, hence oppose their elimination. They have thus fallen for the very simplest scam operated by their opponents in both parties, and by doing so come out against instead of for cutting federal expenditures.

The third alternative is also an expenditure, also a subsidy, should also be opposed by those who wish to reduce the role of government in the economy. But at least it uses a less obvious device, goes to more trouble to hide what it is, than number 2.


ScottO said...

I think your error is in believing what the news stories tell you. I'm sure there are some tea party participants who oppose eliminating tax credits as you describe, but I think there are many of us who recognize them as transfer payments, and are in favor of eliminating them.

If by "Tea Party Republicans" you mean the politicians, I would attribute their opposition to such eliminations as wanting to support popular policy.

Brandon Berg said...

The tax credits that are de facto welfare aren't the ones that are up on the chopping block, are they? I find it very hard to believe that they could ever get the Democrats, or even most Republicans, to sign off on anything that could be described, reasonably or otherwise, as raising taxes on the poor.

Anonymous said...

The bottom 20% does pay federal income tax when Social Security and Medicare taxes (which are taxes on labor income) are included.

Since the tax breaks are specifically for families with children, it's hard to see mainstream conservatives supporting their repeal.

Anonymous said...

Brandon - what?

Welfare is welfare, whether it goes to a poor single mother or a rich corn farmer. Or a bomb maker, abstinence educator, banker or solar panel maker.

Anonymous said...

Assume a selective reduction in taxes is a welfare program. The result is an absurdity. Therefore the assumption is flawed.

Suppose Bob and Bill are both charged $10 in taxes. Then the state reduces Bob's taxes to $5 but does not touch Bill's taxes. That is a selective reduction from the previous state since it reduces only Bob's taxes. This is - it is alleged - a welfare program for Bob. Then, the state reduces Bill's taxes but not Bob's. This is also a selective reduction. Now Bob and Bill are each paying $5 in taxes, and by virtue of this, there is a welfare program of $5 supporting Bob and a welfare program of $5 supporting Bill.

Keep going until taxes are reduced to zero. Now Bob is paying no taxes, and Bill is paying no taxes. So nobody is paying any taxes. And by virtue of this, there is a welfare program of $10 supporting Bob and a welfare program of $10 supporting Bill.

Suppose that Bob and Bill live on a deserted island with Alice. Alice declares herself a state. She declares that Bob's taxes is $10 and Bill's taxes is $10 but she gives each one a $10 tax break, declaring each tax break on a separate day so that each one is selective. So Bob and Bill and Alice are living on a desert island. It follows that Alice is a welfare state that is supplying Bob with $10 and Bill with $10.

But this absurdity follows only if we assume that a selective tax reduction is a welfare program. If we consider that assumption flawed, then the absurdity will not follow.

Henry said...

I think this highlights that a lot of conservatives don't really know why they oppose taxation (or have strange reasons).

The "economist's reason" is that taxes cause deadweight losses. Cutting a tax bracket reduces deadweight losses, giving a tax credit does not change or increases deadweight losses, so they're not the same beast.

The average conservative doesn't think like this, so far as I am aware. They seem to care about the "legal" size of government rather than its actual influence. For another reducto ad absurdum, consider a state where income taxes are 100%, but where all government spending is given in the form of "subsidies" to people in such a way that it would completely replicate their private expenditure had there been no taxes. The government is theoretically "huge" but in practice is anarcho-capitalist with needless churn.

Laird said...

Two flaws with this argument.

First, there are (fairly large) administrative costs associated with the government's paying a subsidy, which are absent when a tax credit is used to affect the same fiscal result. So the two are not entirely equivalent: the tax credit is more efficient.

Second (and perhaps more important), even ignoring those administrative costs, while the economic result of the two actions may be equivalent, the moral costs are not. Your analysis implicitly begins with the assumption that all income belongs to the government, so if, in its beneficence, it deigns to allow someone to keep more of it than it does someone else that is an "expense". That's the flaw with the whole "tax expenditure" argument, of which this is but one example. I support anyone being allowed to keep more of his money; in fact, I think we all should. But failing to tax is not the moral equivalent of an expenditure. Provided that the credit is merely an offset to taxes otherwise due, and not a "negative tax" (i.e., a credit larger than the regular tax amount, which truly is welfare), it is simply stealing incrementally less, albeit from a select group. There are important philosophical differences to the two approaches.

Raphfrk said...

> there is a welfare program of $5
> supporting Bob and a welfare
> program of $5 supporting Bill.

Assuming that they are the entirety of society, then it stops being a welfare program when they are both taxed the same.

Someone who is getting the standard tax rates is not being subsidized. When a special interest gets special (i.e. better) treatment for its members, then that is a subsidy.

One group getting lower taxes than another group is a subsidy. It might be justified due to public good effects, but it is still a subsidy.

mantrid said...

suppose you have a 50% day-to-day inflation. as collecting taxes takes time, donation scenario results in less purchasing power being transferred back to the producer than in tax credit scenario. so it's not just different labeling, it's semantically (and effectively) different. another example is that rather than the producer, the state makes additional money on tax deposits.

actually, state never spends anything, it merely redistributes purchasing power. fiscal policy is all about extent of this redistribution.

$9,000,000,000 Write Off said...

"...consider a state where income taxes are 100%..."

Oh, economists with their ceteris paribus models. Its a pointless diversion to deal with such things, which is why no one listens to economists except people who enjoy quirky diversions.

Our government architecture is laws, not models, and a your typical TP might rationally skip models and focus on laws, especially those passed by A that forces B to pay C as immoral and destructive. In that view, repealing a credit to B to have more to pay C is solely immoral.

$9,000,000,000 Write Off said...

er, not "solely", but "similarly"

Jeff S said...

Wasn't the negative income tax your father's idea? Not conservative enough for you?

$9,000,000,000 Write Off said...

Another medievalish libertarianish critic of conservatives has offered a comprehensive philosophical diagnosis that you might enjoy. Lengthy, but full of tasty historical groundwork.

James Wilson said...

Targeted tax breaks are "subsidies" NOT in the sense that the State is entitled to our income. Rather, they are subsidies in that they distort economic behavior in the same way direct subsidies do. If the market doesn't otherwise demand biofuels, but the tax laws recommend biofuels, an energy company will start developing biofuels. Neither government spending nor government tax policy should manipulate market behavior.

Andy said...

If tax cuts are made across the board it is inevitable that more people will not be paying income taxes.

What the hell is the tea parties problem? They complain about people not paying income tax yet they want fewer people to pay income taxes.

They are a ridiculous extremist fringe that doesn't really know what it wants. It's too bad Ron Paul couldn't take control of them; now it's simply full of morons.

SheetWise said...

"If tax cuts are made across the board it is inevitable that more people will not be paying income taxes."

It's not inevitable, or even logical. It depends upon the reason people are not paying taxes. If, by tax cuts you meant rates, it also doesn't follow. Reagan decreased rates, increased taxes, and more people were paying after the changes.

Anonymous said...

False premise in that Tea-party values would preclude using taxation as a lever to manipulate markets and behaviour

VangelV said...

I think that an error has been made. The Tea Party is not monolithic and many of its members are in favour of the elimination of subsidies no matter how they are labeled.

dmarks said...

Tax breaks are NOT subsidies in any way. Subsidies are a gift, a grant from government. With a tax break, the government gives you nothing. Nada. $0. No subsidy occurs. It is not a grant or a gift to let you keep more of what you already own.

If a mugger steals your wallet but lets you keep your shoes, do you call it a gift from the mugger that you still have your shoes/

Jerry said...

Milton Friedman said, "I never met a tax cut I didn't like".

In that essay, he goes on to say, "Many discussions of the economic effect of tax cuts and deficits implicitly assume that government spending is predetermined and independent of whether there is a tax cut or a deficit. In that world, deficits are produced entirely by a shortage of tax receipts. Raising taxes can eliminate the deficit without affecting spending. As I see the world, the situation is very different. What is predetermined is not spending but the politically tolerable deficit. Raise taxes by enough to eliminate the existing deficit and spending will go up to restore the tolerable deficit. Tax cuts may initially raise the deficit above the politically tolerable deficit, but their longer-term effect will be to restrain spending."

IlĂ­on said...

"The third alternative is also an expenditure, also a subsidy, should also be opposed by those who wish to reduce the role of government in the economy. But at least it uses a less obvious device, goes to more trouble to hide what it is, than number 2."

I would say that the third alternative is the worst of the lot, for it is at least as (and quite possibly) directly destructive of wealth, while more effectively hiding that destruction.

"But at least it uses a less obvious device ..."

It better disguises and obfuscates the nature of the subsidy; this is hardly something about which I'd say, "at least it ..."

PirateFriedman said...

I was surprised to see David making this comment. To me a tax cut for ethanol is different from a tax on regular gasoline. One lowers the overall tax burden and one raises the overall tax burden.

If you view the overall tax burden as the most significant feature, then this is extremely important. One could say that if enough special interest groups eventually fight for nonrefundable tax cuts, the tax rate eventually goes to zero.