The Hidden Hand of Government Spending: Tax Expenditures Distort Government Budgets and the Political Process
Kleinbard, Edward D., Regulation
The late economist David Bradford was fond of a joke that he constructed to illustrate the intersection of tax law and the budget process. He would propose a marvelous new way to cut taxes without affecting government services: Instead of wasting tax revenues on military equipment purchases, Congress could implement a "Weapons Supply Tax Credit," under which arms manufacturers would receive a tax credit for delivering to the U.S. Government weapons meeting certain specifications. The amount of the credit would equal what Congress might formerly have spent on purchasing those weapons. Then Congress could announce that, through this "targeted tax relief," taxes had been slashed without jeopardizing our security or increasing the deficit.
The joke, of course, is that nothing at all would have changed; the federal government still would obtain the same weapons and incur the same economic cost to do so. Our accounting for the transactions, however, would differ. Instead of recording government revenues from taxes collected and government expenditures for national defense, we would just report net lower taxes collected. Before, the government took in $1,000 and spent $100 on fighter planes. After, the government would record just $900 in revenues, and some "free" planes would arrive at the Air Force's doorstep. On paper, the government had gotten smaller; in reality, it would be as large as ever.
Bradford's joke is meant as a gentle parody to illustrate the empty formalism of our concepts of government revenues and expenditures. When the government subsidizes people or businesses by writing them checks, we all recognize that intervention as government spending. When the government subsidizes the same people or businesses to the same extent by giving them a targeted tax break, that action often is mischaracterized as "lower taxes" or "smaller government."
Specialists term these synthetic government spending programs "tax expenditures." Tax expenditures are really spending programs, not tax rollbacks, because the missing tax revenues must be financed by more taxes on somebody else. Like any other form of deficit spending, a targeted tax break without a revenue offset simply means more deficits (and ultimately more taxes); a targeted tax break coupled with a specific revenue "payfor" means that one group of Americans is required to pay (in the form of higher taxes) for a subsidy to be delivered to others through the mechanism of the tax system.
Like all parody, Bradford relies on hyperbole to make his point. How, then, would he have reacted to an Internal Revenue Service news release from April 6th, 2009, announcing the publication of Notices 2009-23 and 2009-24? The first of those notices explained to taxpayers how to apply for $250 million in tax credits to be allocated by the IRS and the Department of Energy (surely a bureaucratic odd couple) for delivery of certain "Phase II [qualifying] gasification projects." The second announced $1.25 billion in tax credits to be awarded, again by the same two agencies, for certain advanced coal facilities. In effect, the notices announced the transfer of hundreds of millions of dollars from the federal government to selected energy companies.
Bradford's joke has lost its punch line. We now find ourselves living inside the parody and thinking it normal.
Tax expenditures have grown in importance to the point where they are now the dominant instruments for implementing new discretionary spending policies. We spend more than twice as much through tax expenditures as we do through old-fashioned explicit non-defense spending programs. Tax expenditures dissolve the boundaries between government revenues and government spending. They reduce both the coherence of the tax law and our ability to conceptualize the very size and activities of our government.
Tax expenditures not only distort tax policy and obfuscate our understanding of government operations; they also adversely affect the workings of Congress. …