Jul 2, 2018

Government Privilege: Using and Abusing the Tax Code

Matthew D. Mitchell Director of the Equity Initiative , Tad DeHaven Research Analyst

This is the first in a series of short commentaries on The Bridge that discusses the various types of privileges that governments bestow on particular businesses or industries.

Concerns about inequitable tax provisions date to the nation’s founding. Indeed, the impetus for the infamous Boston Tea Party was the British government’s Tea Act of 1773, which reduced the tax on tea sold in the American colonies by the struggling East India Company. This tax privilege allowed the British government-sponsored East India Company to effectively undercut the competition and threatened to give it a monopoly on the tea trade in the colonies.

Today, thousands of US companies benefit from special provisions in both federal and state tax codes that offer “targeted tax relief” to particular firms or industries. Earlier this year, for example, Congress resuscitated a slate of expiring tax privileges including targeted benefits for rum producers, racetrack operators, and a variety of commercial energy interests. At the state level, dozens of states entice film production companies with tax credits and other benefits. State and local officials also offer tax incentives to specific businesses under the guise of fostering economic development, even though the evidence shows that such privileges do not deliver broader economic benefits.

Since targeted tax breaks are often no more than subsidies in disguise, policy experts refer to them as “tax expenditures.” The Congressional Budget and Impoundment Control Act of 1974 defines tax expenditures as “those revenue losses attributable to provisions of the federal tax laws which allow a special exclusion, exemption, or deduction from gross income or provide a special credit, a preferential rate of tax, or a deferral of tax liability.” However, not everything that gets labeled a tax expenditure should be. For example, preferential treatment of capital gains can be justified on the grounds that it helps mitigate the problem of double taxation under the current tax code.

Tax expenditures that are genuine tax privileges are more concerning. These tax provisions are intended to provide a targeted benefit to a particular commercial interest. Although that sounds cut and dry, experts – including those with similar ideological leanings – often disagree on whether a particular tax provision is truly a privilege. For example, some argue that accelerated depreciation provisions constitute an undue tax loophole. We would argue, however, that accelerated depreciation lessens the economic damage caused by taxing capital investment and thus the focus should be on moving to full expensing across the board.

Unfortunately, special interests who benefit from targeted tax provisions employ specious, yet politically attractive, arguments to justify their tax privilege. For example, housing and banking lobbyists argue that the federal mortgage interest tax deduction encourages homeownership. In reality, it merely encourages people to purchase more expensive homes and incur more debt, which translates into more money for realtors and lenders.   

As Mercatus scholars and other experts have explained, tax privileges create a bevy of problems. The most obvious one is that when a particular firm is given a tax break, all other taxpayers – including non-privileged businesses – are effectively forced to pay higher taxes to make up the difference. Consumers are hurt when businesses spend time and money focusing on securing favorable tax treatment from policymakers instead of using those resources to create new and better products. Indeed, this corruptive “rent-seeking” deepens the morass that the tax codes have become as commercial interests fight to gain or maintain their privileges. (The extreme complexity of the federal tax code alone costs the economy somewhere between $218 and $987 billion each year in compliance costs.) This complexity fuels a massive tax industry to deal with administration, tax filing, planning, enforcement, avoidance and other related matters. It would be more beneficial to society if such resources were instead put to more productive uses. Indeed, the cumulative effect of the misallocation of resources and distortions to economic activity caused by tax privileges is an overall reduction in the country’s prosperity.     

Learn more: In The Pathology of Privilege: The Economic Consequences of Government Favoritism, Matthew D. Mitchell identifies multiple forms of government granted privilege (including tax privileges), and explains their consequences. The full special report is free of charge via pdf, and is available for purchase as an ebook and paperback at Amazon.com and CreateSpace.com.

Photo credit: Andrew Harnik/AP/REX/Shutterstock

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