Free Markets, Free People

tax subsidies


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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