The “Thin Edge of the Wedge” outcome and “American Feudalism,” discussed in earlier posts, provide greater public benefits to those who have more, but do so by stealth or accident rather than by design. The provision of public benefits and subsidies through the tax code, on the other hand, clearly and unambiguously follows the “golden rule” — he who has the gold makes the rules. Tax subsidies are preferences are the opposite of means-tested benefits. Under means-tested benefits, the less you have the more public assistance you get, at least in theory. Tax breaks provide greater public benefits to those who have more, not those who have less. And more and more, tax breaks are the public policy of choice for allocating public benefits.
The amount of money involved is not trivial. The $632 billion in tax revenues lost due to federal tax breaks in 2000, as identified in the U.S. Census Bureau’s 2001 Statistical Abstract of the United States, was substantial relative to the $1,789 billion in federal expenditures that year. All three levels of government spent $37 billion on housing subsidies and community development, but federal tax breaks for those purposes cost $92 billion, with the mortgage interest deduction alone costing $60 billion. The loss of state and local income taxes from the mortgage deduction is on top of that. The exclusion of health insurance premiums from taxable income cost the federal government $76.5 billion in 2000, with state income tax losses on top of that. In 1998, federal, state, and local Medicaid spending for the merely poor, rather than the disabled or elderly, totaled just $41 billion. In recent years, there has been an explosion of tax benefits to subsidize college education. Direct federal expenditures on college scholarships were lower in 2000 than in 1990.
Some have argued that allowing people to pay less into the government is fundamentally different that allowing people to take more out of it, since the former makes the government “smaller” and the latter makes the government “larger.” For those who do not receive a tax benefit or spending benefit, however, the effect is the same – they either have to pay more in, or accept less out, to make up for what others receive. If tax breaks made the government “smaller,” then a 100 percent tax rate, with money returned for different tax preferences to those who do what the government seeks to encourage and subsidize, could make the government “smaller” than it is today. That is absurd. That is, in fact, slavery.
Who received the $632 billion in federal tax breaks, and the additional funds allocated by state and local tax breaks?
For personal and corporate income taxes, there are two kinds of tax break, a credit and a deduction. A credit reduces the amount of tax owed, while a deduction reduces the amount of income subject to the tax. A $1,000 tax credit, for example, would provide a $1,000 subsidy to someone who would otherwise owe $1,000 in taxes, and a $1,000 subsidy to someone who would otherwise owe $100,000. On a percentage basis, credits are more valuable to those with lower incomes, since their tax burden could fall by 100 percent; in contrast someone who would otherwise owe $100,000 would have his or her taxes reduced by just one percent. According to the 2001 Statistical Abstract of the United States (table 474), however, those earning less than $15,000 per year and filing a return owed, on average, less than $1,000 in federal income taxes. A $1,000 federal income tax credit would be worth less than $1,000 to them. Many more low-income workers are not even required to file, so an income tax credit provides them with nothing. So a tax credit is worth more to those with lower incomes up to a certain point, when it becomes worthless.
A tax deduction, on the other hand, is worth more to those with higher incomes up to a certain point, when it becomes worthless. A $3,000 deduction, for example, would reduce one’s state and local taxes by $1,200 if he or she were affluent enough to fall into the 40 percent marginal tax bracket, by $1,000 in the 33 percent tax bracket, and by just $600 in the 20 percent tax bracket. For those whose income is so low that no taxes would be owed in any event, the tax-based benefit would be zero. Moreover, less than one-third of all federal tax returns include itemized deductions, rather than the standard deduction. For those using the standard deduction, the value of any additional tax break that doesn’t reduce taxable income off the top (as the exclusion of retirement savings and employer health insurance premiums does) is effectively zero. The working class, and much of the middle class, has thus received no benefit from all the tax breaks added since the 1986 tax reform. The truly rich also frequently receive nothing, since many tax credits and deductions phase out, and the alternative minimum tax phases in, above a certain point.
Most of the benefit from the profusion of tax breaks over the past 20 years, therefore, has gone to two-income, college-educated couples whose total earnings place them in the upper middle class. Suburban, college-educated whites, the “soccer mom” voters, those in the same social group as most elected officials, in other words. The rising inequities have been enough to even shake the conscience of some conservatives, whose perspective generally is that big government has allowed the “less deserving” to be better off than they should be. This is particularly the case for health insurance, where Republicans are presiding over an era in which the amount of federal tax subsidy to the affluent rises every time the cost of health insurance does, even as millions lose their health insurance and, therefore, their subsidy.
There is a way to use the tax system to provide an equal benefit for everyone. The government could offer a benefit that could be either a tax break or a voucher. The voucher option would ensure that everyone received, say, $1,000 even if no tax were owed, while those who owed more than $1,000 in taxes could just take a credit against them. Either way, the dollar value of the benefit would be the same for everyone, from the richest to the poorest, and everyone would be assured of being able to afford whatever service was being subsidized, up to at least that value. At this point, however, the Earned Income Tax Credit is one of the few examples of a refundable tax credit. In the year 2000, many in Congress proposed cutting the EITC to pay for tax reductions, on the grounds that the EITC is big government “welfare” for the undeserving working poor. Remarkably, that proposal did not pass. Or at least it has not passed yet.