Income tax – or consumption tax, and: what I think about tax credits

So I’m still writing in general terms about tax reform, since the actual Republican tax proposal seems to still be evolving.

Here’s what I’m thinking:

Tax deductions are largely premised on the idea of “this is money you didn’t get to enjoy spending, so it’s unfair that you should have to pay taxes on it.”

Medical expenses:  it’s kind of unfair that you had these expenses, and it pinched you financially, so you shouldn’t have to pay taxes on this part of your income.

Charitable deductions:  good for you that you sacrificed some of your income towards worthy causes; it would be unfair to tax you on the income that you sacrificed.

State and local taxes:  you didn’t get to benefit from this income personally, so why should you pay taxes on it?

Work-hunting expenses, child-care costs, etc.:  this was just income you needed to pay out, in order to earn money.

Education-related tax deductions:  hard as these are to actually make use of, they are still in the category of “unfair to make you pay taxes on this income.”

Savings:  great that you saved; we’ll tax you when you actually use this income.

Standard deductions:  this is money that you need for your basic living expenses.  Unfair to ask you to pay taxes on it.

Even the mortgage interest tax deduction, though it now appears as just a giveaway to subsidize homeowning, didn’t start out that way.  According to Wikipedia, it is the vestige of what was originally the ability to deduct interest on all personal loans, and there was no home-subsidy intent because income tax payers were originally only the wealthy.  But “the reason for the deduction was that in a nation of small proprietors, it was more difficult to separate business and personal expenses, and so it was simpler to just allow deduction of all interest.”

In other words, the concept of tax deductions is a roundabout way of turning the income tax into a consumption tax.  But should it be a consumption tax?

Tax credits, on the other hand, or, strictly speaking, refundable tax credits, well, those are really not a part of the “tax system” at all.  These are government benefits that are paid out through the mechanism of the IRS because it’s logistically simpler than filing a separate form, to the Internal Payments Service, to claim the various payments that the federal government has decreed individuals or households who meet certain criteria, be paid.  A refundable child tax credit is really no different than the “child benefit” that various Western countries provide.  Likewise, the Earned Income Tax Credit is just a government benefit to supplement the incomes of very low income people.  Or the adoption tax credit.*  Or the tax credit for schoolteachers buying supplies.  Or the tax credit for purchasers of hybrid cars.  (Question for readers:  should we go ahead and replace the minivan with a hybrid Pacifica while we can still get the credit, or drive the old one around until it falls apart from rust?)

Should they be a part of the tax reform bargain?  Only to the extent that any other form of government benefit is or isn’t.  But the fact that these sorts of government benefits are administered by the IRS has made us a bit stupid in this regard.

What about nonrefundable tax credits?  I’m not really a fan.  It’s a sort of hybrid between a deduction and a “government benefit paid out via the IRS,” whether to disguise the fact that this is what they are, or to minimize the amount of money paid out, or because it’s viewed as particularly important to “save” people from paying taxes via these mechanisms.

Here’s a local example:  in Illinois, the latest round of education funding negotiations produced a tax credit scholarship program:  individuals will receive a 75% tax credit on their donations to scholarship funds to enable low to moderate income children to attend private schools.  Why did they adopt this mechanism?  Because it allowed for the fiction that it wasn’t the government that funded the program.

Or consider the adoption tax credit.  It provides up to $13,570, but it is nonrefundable, so most lower-income families won’t benefit, and those with moderate incomes will need to continue to carry forward unused credits over the 6 year period.  Is there any rationale behind the nonrefundability of the credit?

And it’s now on the chopping block, in the same manner as, so far as I understand, other similar credits are.  I had read somewhere along the way that there are some who consider this credit suspect — since adoptions of foster children are “free,” the primary beneficiaries are those who are adopting foreign children, which means that it’s not helping American children, and those foreign adoptions are suspect, anyway.  Another set of beneficiaries are individuals adopting American babies in the classic “unwed mother gives up her child to a couple who pay her expenses.”  In any case, whenever an adoption is exceptionally expensive, the amount of the credit might not make a real difference in whether parents undertake the adoption.  At the same time, if a child is adopted from foster care, even if the foster care system already pays all of the costs and even provides financial assistance, the parents automatically are eligible for the full amount of the credit without documenting expenses.  Here’s a critic of the tax credit who complains that adoption exploits poor women and that the tax credit should instead be directed towards the mothers themselves to help them, rather than the middle class families adopting their babies.  But, as usual, now that this is in the news, any pre-tax reform proposal discussions of the worthiness of this tax credit are lost in the flood of new complaints of its elimination.

In any case, this is a prime example of a tax credit that really has nothing to do with tax policy.  Should the government subsidize adoptions?  If so, what sort of adoptions should they subsidize, and for which groups of people?  Should people get more benefits, if they’re wealthier?  Should they get a windfall, if they’re poor?  Should international adoption, private domestic adoptions, adopt-from-foster, and adoptions of relatives all be treated the same?  These are general public policy questions, not tax policy questions.

Up next:  the post in which I finally suck it up and look at the proposal itself.  (Spoiler alert:  I’d be fine with eliminating the inheritance tax if you likewise paid capital gains based on the original purchase price, not the stepped up value — but I also think that cost basis should be inflation-adjusted.)

Image:  https://commons.wikimedia.org/wiki/File%3AMoney_Cash.jpg; By Jericho [CC BY 3.0 (http://creativecommons.org/licenses/by/3.0)], via Wikimedia Commons