Tax Credits: Social Policy in Bad Disguise

Article excerpt

Most analyses of the Clinton administration's new budget focus on reforming Social Security and cutting taxes, but have largely overlooked a disturbing new trend in tax policy - the increased use of credits.

This year, the administration has proposed credits for inner- city investment, home health- care, families with children less than a year old, environmental programs, and a host of additional items. Following on the heels of expanded earned-income credits in 1993 and new child and education credits in 1997, these proposals will create numerous problems and will plague tax policy for years to come.

The rise in the use of credits is probably best seen as the outcome of an ill-fated political compromise. Republicans like credits because they look like tax cuts. Democrats like them because they advance social policies without raising government spending. Both sides are getting a bad deal. Unfortunately for Republicans, targeted tax credits do not make government smaller. It's true that a spending program raises official government outlays, whereas a credit does not. This occurs because the budget records the expenses associated with a credit as a reduction in tax revenues, rather than as outlays. But this does not mean that government has claimed less of the private sector's resources when using a credit, because, in either case, the program has to be financed. For example, if the government enacted and raised revenues to finance a $1-billion-spending program, the budget would record an added $1 billion in spending and $1 billion in revenues. In contrast, if a $1-billion tax-credit program were enacted and financed, official program outlays and revenues would both be zero. In either case, though, the government would have to raise $1 billion in tax revenues to provide the spending or the credit. Unfortunately for Democrats, credits are a poor way to administer social policy. Unless the credits are refundable - that is, unless they actually give people cash back instead of just reducing tax liabilities - they will not help low-income households. New nonrefundable credits would be useless to families of four that earn less than $28,000, because they already pay no federal income taxes. In fact, about a third of the nation's children live in families with incomes too low to receive any benefit from the child credit enacted in 1997. …