Free Markets, Free People

Tax subsidies are a thing.

Many on the Right despise the very idea of a “tax subsidy” and think that a targeted tax credit or deduction is just letting people keep their money.  To say otherwise, so the conventional wisdom goes, is to assume that the government owns all our income.  I think there’s a well-meaning error in this thinking, and I’ll illustrate that with a simplified example.

Two countries are running deficits, or start with balanced budgets (take your pick).  Country A decides that next year they’re going to establish a tax credit for farmers worth $X.  Country B decides that they’re going to send an equal amount, $X, to their farmers as direct subsidy payments.

  • In both countries, farmers have an extra $X in their pockets.
  • Both countries must borrow an extra $X, meaning that future taxpayers in both countries are on the hook for $X plus interest.

There might be a minor difference in efficiency between having the IRS administer a tax credit and having the Department of Agriculture cut checks, but everything else is basically the same.  Yet Country A acted through the tax side of the ledger, while Country B acted through the spending side.  If Country B is subsidizing its farmers, then so is Country A.  Hence, tax subsidy.

There’s no trick here.  The key is that it’s not all about the spending and tax rates this year.  It’s about future taxpayers too. If current taxpayers don’t pay for what the government is spending this year, then future taxpayers must.  A deficit-financed “tax cut” without a spending cut is just shifting taxes into the future.  That doesn’t lower the long-term burden of government.

Importantly, there’s no claim here about who should pay, this year or in the future.  But the people who are really being “subsidized” are those who would be most politically vulnerable to getting taxed today if the burden wasn’t shifted onto future taxpayers.

Some on the Right say that if we raise taxes today, that won’t save future taxpayers anything because the government will just spend all the new revenues and then some, and we’ll be back in a deficit.  So we might as well “starve the beast” by cutting taxes, right?  That may have some strategic merit, but there’s still a tax subsidy to whatever extent “starving the beast” doesn’t work, and since big deficits tend to raise interest rates, there’s a built-in compounding cost to future taxpayers, so you better hope the strategy works well.  In the meantime, accepting big deficits makes it easy for supposedly small-government legislators to justify protecting their buddies first, and constant borrowing by its nature tends to risk fiscal crises.

Yes, cutting spending is harder than cutting taxes.  Promises to change tax rates and keep them there are more credible than promises to cut spending levels.  But spending is where the real battle is, so anyone who wants to carry the small government banner should be at least proportionally more credible on spending than he is on taxes.

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17 Responses to Tax subsidies are a thing.

  • Wow.  All that verbiage, and you still managed to get that pretty much entirely wrong!
    MY government allowing me to keep my money is not a “subsidy” to me.  It is not largess.  It is not benevolence.
    If I earn a dollar and Joe steals a dollar, we both have a dollar.  See, your argument breaks down completely on the morality end.

    Some on the Right say that if we raise taxes today, that won’t save future taxpayers anything because the government will just spend all the new revenues and then some, and we’ll be back in a deficit.

    What you should have written was, “HISTORY–and human nature–TELL US that if we raise taxes today…”.

    • It may not strike you intuitively as a subsidy, but you haven’t addressed the examples I raised.  Your fallback position here, if you have one, is that in Country A future taxpayers are forced to pay for something for which farmers would have been required to pay, like the military or underwater basket-weaving, and that’s the real subsidy.  But it’s all the same to the people who continue to benefit from the same government spending; the only change in material terms in both countries is for farmers and future taxpayers.

      • And you are ignoring my example of my earning a dollar and Joe taking a dollar.
        Both of us have a dollar.
        Someone else is out a dollar.
        But there is no morality to Joe’s theft, and NOBODY “subsidized” my earned dollar.
        Perhaps we could agree on this; our current tax system is irretrievably immoral.  There are several MUCH better systems that could be devised, but ALL would have to be guarded from the same corrupt practice of using the system to promote some activities, while discouraging others.  The sole legitimate purpose of a tax system is revenue generation.  AND NOT REDISTRIBUTION…to ANYBODY.

        • What’s the moral difference between borrowing money to (a.) reduce a farmer’s tax bill from $100 to $50 and (b.) cut a $50 check to the farmer and collect the usual $100 tax?  The same amount of money is taken (under the threat of overwhelming force) from future taxpayers in Country A and Country B.

          And saying that the purpose of a tax system is revenue generation doesn’t give us a good guide to what we should tax.  The only way to totally avoid promoting and discouraging various activities is to levy a single capitation tax, and that isn’t going to happen.

          So we have to set priorities on what to tax.  And some common activities that cause dispersed harm (like many cars polluting the air so that it eventually becomes harmful just to breathe), are not suited to be efficiently decided in courts.  There are limited circumstances in which we’re very confident that substantial harm is being done and taxing the activity turns out to be the least damaging way to minimize harms.  I’d rather tax something like that than tax, say, labor.

          My favored tax system, I suppose, would be a consumption tax with some Pigouvian taxes on the side.

  • I think the major benefit to credits instead of subsidies are (1) you don’t waste your money on the bureaucracy dedicated to writing the check to give your money back to you and (2) many of them are based on proportions of expenses (and generally less than 50%).  Nobody is going to do an activity just to break even.
    But yes you’re not really doing anything different, once you accept the concept of things like income tax then you’re already working for the government.

  • Two countries are running deficits, or start with balanced budgets (take your pick).  Country A decides that next year they’re going to establish a tax credit for farmers worth $X.  Country B decides that they’re going to send an equal amount, $X, to their farmers as direct subsidy payments.
    In both countries, farmers have an extra $X in their pockets.
    Both countries must borrow an extra $X, meaning that future taxpayers in both countries are on the hook for $X plus interest

    I suggest that there is an important psychological difference.  In the first case, the tax revenues clearly aren’t there; you can’t spend it if you don’t have it (well, most of us can’t!).  In the second, tax revenues appear to be higher; there is merely another spending program to drain them.

  • Assuming that one man is entitled to another man’s labor is to accept slavery as a viable form of governing. Further, when a child is born already tagged with debt owed, that child is indentured without choice and their life is owned by those managing the entitlements. Governments modeled on Marxist’s principles always devalue life and will inevitably fail.

    When I look at DC, I see addicts planning the procurement of their next fix.

  • Well there is one crucial difference even if the monetary situation is somewhat the same… The government must choose what it will subsidize.

    In case (A) the farmer retains $X of his own money and can choose to spend it on capital equipment, stock, feed, debt servicing, expansion, employees, or save it.

    In case (B) the government decides to subsidize something the farmer does, the farmer must do that to get the money back. Likely this will be a political decision and not what is needed by the market or farmer and so on top of the churn of processing the tax and subsidy it also directly wastes a good fraction of the $X with misallocation.

    Therefore the subsidy is market distorting and generates waste and this is exemplified by the EU’s common agricultural policy. While the two scenarios appear equal they really aren’t, in the long run for the whole economy.

    • The government attaches strings to both tax credits and direct payments.  And the timing isn’t necessarily all that different: the direct payment check can be sent just as quickly as the tax credit can be claimed (for a smaller tax bill or a bigger return), I’d think.

      • OK, I thought you meant that the tax credit would be gained merely for being a “farmer” and would not be directed (much like a family tax credit is given to families regardless of what it is spent on).

  • “Definition of SUBSIDY

    : a grant or gift of money: as a : a sum of money formerly granted by the British Parliament to the crown and raised by special taxation b : money granted by one state to another c : a grant by a government to a private person or company to assist an enterprise deemed advantageous to the public”

    How do you grant or give someone else’s property? Try that in the real world and you will find yourself doing, at best, a lot of community service, if it is your first ‘grant’ or ‘gift’.

  • There is a difference – if the government that doesn’t take it as tax has half a brain it’s not running constant deficits, or putting the ‘tax’ into an ‘account’ (Hello social security) where it will be safe from politicians buying votes.
    You can’t treat money merely as a means of exchange to predict how this is going to work.
    Money the government doesn’t take is safer than money the government takes and divies out, even though they are both a means of subsidy.
    Your points are valid, I see what you’re saying, but knowing human nature, the country that lets the farmer keep his money instead of taking it and redistributing it is, over time, more likely to NOT find itself in the situation we are currently in. 
    There’s a psychological difference in not taking the money and in taking it and parceling it out that WILL work it’s way into the thinking, and voting, of the political class, and the electorate, as it HAS done to ours.
    So in the short term your argument probably holds water, over time (think, say, the time period of the US) it will have an effect and you’ll get what we have today – entitlement (subsidy, if you will) spending and no intention of restraining the spending process.

  • I think the problem is that the contexts for discussing the issue are often conflated and confused.

    Here, you are talking about tax “subsidies” from a budgetary POV, in which you are exactly right — i.e. to the ledger, there really is no difference between revenue purposely foregone or spent.

    In the semantic context, as I’m sure you know, the term “tax subsidy” is a misnomer since it does not involve a transfer of money (as opposed to, say, welfare payments).  It is true that tax subsidies/cuts/etc. without commensurate reductions in spending (assuming no tax surplus and static budget) are a potential transfer from future to taxpayers to current ones.  But, again, that’s in the budgetary context, not the semantic one.  Of course, apart from the philosophical discussions that seem to only take place in dark corners of the internet, this semantic argument is hardly one to get worked up about.

    Where the real argument comes is in the moral context.  Alex Tabarrok points to a perfect example:

    Catherine Rampell, Bruce Bartlett, and Matt Yglesias are all pushing the chart below from a paper by Suzanne Mettler. According to this gang, people who use, for example, the mortgage interest deduction or who have a 529 college savings program are willfully ignorant about how they benefit from government (Rampell’s terminology).


    People who use 529 programs and who think that they have not used a government social program are not willfully ignorant, they are demonstrating a healthy if fading appreciation of the distinction between civil society and government.  What Rampell et al. implicitly imagine is that the natural state is slavery and any departure from that state a government benefit. Thus, if the government taxes your saving for a college education less than your other savings, you should be grateful for how government has benefited you and your children.

    And if the government doesn’t jail you today, you should be grateful for how government has granted you the benefit of liberty.

    This is the attitude of a serf not an American.

    Alex gets it exactly right — in the moral context.  People who complain about the burden of too much government and high taxes are not hypocrites because they happen to take advantage of particular laws that amount – in the budgetary context – to tax subsidies.  Again, absent government action to make the “subsidies” revenue neutral (e.g. spending cuts), then there is a budgetary transfer.  But these people have not been given anything.  The government has simply refrained from taking more of what’s already theirs to begin with.  (And this is all besides the rather odd argument that the people who already pay the most in taxes should be grateful for the “subsidies” they receive from the government in the form of lower taxes.  IOW, they should be grateful for the implied transfer of tax money they paid back to themselves.)

    Commentators such as Rampell, Bartlett and Yglesias try to make the case that everyone owes their livelihood to government.  Therefore, as the argument goes, those who prosper the most have some moral responsibility to pay more for that government, especially since their increased wealth can be directly traced to specific government largesse in the form of “tax subsidies.”  It’s all hogwash, of course, but their moral argument should not be conflated or confused with the very reasonable budgetary observations that you made above.

    • But it’s the very appeal to morality that gets us into the situation we’re in.  It’s not moral to let Bob and his kids starve because; Bob had too many kids, or Bob drinks and won’t work, or…whatever it was Bob did or whatever it was that happened to Bob that makes him a burden (properly called a dependent of course) to a moral society.
      By virtue of our chosen morality, in some ways we are taught to believe we OWE Bob, or Bob’s children, or Bob’s wife, whatever the circumstances were that made Bob unable to take care of his own situation.
      Then people with a ‘higher moral sense’ than some of the rest of us, who perhaps tired of helping Bob on their own or were unable to help him as much as they’d have liked, went into politics and decided ALL of us should help Bob out and pay our obligation to Bob, who made us obligated to him by being born into our society.
      It’s not so much that we owe our livelihood to the government, the government is just a giant hopper, as it were, where we pour the money that we’re using to fulfill our civic obligations to build roads, and harbors and schools.  It’s also the hopper where we now pour money for our moral obligations.
      Lately since we’re doing so much in entitlement spending, we in fact owe much of our livelihood to the Bobs, the village ‘unfortunates’.

    • “i.e. to the ledger, there really is no difference between revenue purposely foregone or spent.”

      My accounting is a bit rusty. Is ‘revenue purposely foregone’ a debit or credit?

  • I think an excellent start would be for all “tax credits” to be termed “public subsidy” on the tax code.
    Also, Bryan, what do you say to people like Obama who raised some tax credits for poor people and then called them tax cuts. Isn’t he playing the same the right is?
    This is why I think the terminology should be changed, and the way “tax cuts” can be counted should be defined.