Most Tax Credits Are Bad Tax Policy

The false choice for conservatives in Congress is: ExtendUnwarranted tax cuts to a few politically-favored entities or allow federal government to collect more taxes to fund reckless government spending.

From that lens, it’s unsurprising that some choose to renew the tax breaks, even though it goes against a fundamental principle of prohibiting government from picking economic winners and losers.

But conservative members of Congress must recognize that if the federal government stays on its current path—having accumulated $6.6 trillion of new debt in the last two years alone—they’ll get the worst of both worlds. Unsustainable budget deficits could force Congress to raise taxes in a way that is not sustainable, while the U.S. tax code continues to be littered by tax breaks for the privileged few.

The best of both worlds is also possible—if Congress will act quickly to stop America’s fiscal problem at the source. Congress can make this happen by reducing runaway federal spending, and reforming entitlement programs. Ultimately, that’s the only way to prevent disastrous tax increases that are looming for nearly every working American if we remain on our current trajectory.

In the meantime, Congress should not extend the temporary tax credits that ended in late 2021. Every tax credit Congress grants to a select few ensures that all taxpayers will have to pay more.

There are 25Temporary tax credits that expire in 2021, including temporary extensions of existing credits. Some tax credits were created by the 2020 Coronavirus Aid, Relief and Economic Security Act (CARES) or the 2021 American Rescue Plan Act. Other “temporary” tax credits have their roots in Great Recession-era stimulus bills.

If history repeats, Congress may retroactively extend many of these tax credits for one year or more.

Before I continue, it’s worth highlighting the difference between tax deductions and tax credits, as tax credits are much more likely to be problematic.

Tax code allows for tax deductions for legitimate business expenses. Deductions reduce your taxable income while a tax credit is a dollar for dollar reduction of your actual tax liability.

A $100,000 tax deduction would reduce $500,000 taxable income to $400,000, for example. If you have a 21% tax rate business, your total tax would amount to $400,000 x 21% = $84,000

Instead, you could get a $100,000 tax credit. Your total tax before the credit would then be $500,000 x 21% = $105,000. However, you would then get a $100,000 credit to reduce your tax liability, leaving you only $5,000 in tax.

Major economic distortions are caused by tax credits that push people and businesses into making economic decisions to get the tax benefits.

Tax credits are often arbitrary. They have percentages, amounts, and limits that policymakers set based on little or no economic basis. Tax credits are easy to manipulate because they are often created randomly. They are a popular tool for lobbyists, policymakers with a penchant in central planning, and are a favorite tool.

The tendency for Congress to increase, decrease, and extend tax credits based on who’s holding the political football creates even more economic distortions, as businesses and individuals time purchases or other economic decisions to maximize their credits.

James Madison pointed out legislatures’ temptation to use tax policy to the advantage of the political majority when he wrote, “Every shilling with which they overburden the inferior number is a shilling saved to their pockets.”

Congress should stop abusing tax code and should not extend any 25 expired tax credit provisions.

Seven tax credits that are expiring in 2019 are energy-related. These include credits for qualified fuel cells motor vehicles, alternative fuels such as electric scooters or motorcycles, second generation biofuels, renewable electricity and Indian coal, as well as credits for alternative fuel vehicle refueling properties.

These credits, taken together, can lead to misallocations of private resources and distortions in the energy market. Companies invest resources in impractical technologies, which the government artificially props-up, while shifting resources away more efficient and productive options.  

Four expiring tax credits incentivize different forms of paid leave—at a time when employers face a historic labor shortage.

Other expired tax credits can cause distortions in other areas of the economy, such as housing, building construction, wages and the health insurance markets.

The 2021 expansion to the child credit is the most controversial expiring credit. These can be better described as child cash grants because most of the payments were made to parents who owe no taxes.

The child credit that was in effect prior to 2021 didn’t expire; only the expanded grant did. Therefore, it’s set to revertInstead of the $3,000 credit for children aged 6 and under, which was in effect in 2021, it will now be $2,000 per child. Unless the 2021 expansion is renewed, limits will also be reinstated on the amount of tax “refunds” that will be paid out to individuals who pay no income tax.

The cost to extend the expanded credit for children would be about $600 $100 billionEach year, new deficit spending. As the Federal Reserve struggles to control inflation, it would be irresponsible for Congress to increase our current deficit. Furthermore, since the 2021 child credit policy dropped work requirements and paid people who didn’t work, extending it would only exacerbate the labor shortage that’s holding back the economy and further contributing to rising prices.

In general, temporary tax credits don’t offer the widespread tax relief that policymakers should seek. Indeed, with $29.7 trillion of debt and counting, unless combined with spending cuts, tax credits merely shift the burden of taxes to all those taxpayers who don’t qualify for them.

Tax credits distort the markets by having government pick winners it will subsidize and making losers from the rest. They also artificially change market prices and push consumers to buy products the government likes rather than those they prefer.

Tax credits allow recipients to avoid the pain of some taxes. They often encourage people to support more big government, while others are left to pay a larger bill.

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