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Monthly Archives: April 2016

The U.S. Tax code: All things to all politicians

19 Tuesday Apr 2016

Posted by Keith Thompson in Tax Reform

≈ 2 Comments

As America welcomes the close of the 2015 tax filing season we are again embroiled in yet another combative discussion of just how best to reform the very cumbersome tax code. The current U.S. tax code has been used by many a politician to solve numerous social and public ills from poverty alleviation, to promoting housing, college participation and business investments. Along the way the disjointed nature of these individual programs have led to painful unintended consequences and a situation where, in aggregate, they may now be counterproductive.

Consider first the mortgage interest deduction. It was specifically carved out of the 1986 tax reform bill primarily to help promote home ownership. However, over the past 30 years it has done anything but. This deduction currently costs the Federal government some $70 Billion annually in lost revenues but ends up being principally utilized by holders of large mortgages, not first-time home buyers. In addition, it provides an unintended disincentive to renters who do not qualify for such tax benefits. That in turn forces many of those renters to accelerate home purchase before they are financially qualified to do so, further increasing the risk of foreclosures down the road. This deduction is widely viewed by many economists to not have the intended public policy benefits. In fact, to no one’s surprise, only the real estate industry supports keeping this deduction in the tax code.

Another deduction worth considering is the student loan interest deduction. The 1913 Revenue Act allowed deductions for all personal interest expenses (including student loan and credit card interest) before the 1986 tax reform bill eliminated those write-offs. In 1997 – after bowing to intense political pressures – the student loan interest deduction was reinstated. Continued economic and legal analysis since then have revealed absolutely no positive benefit to society as individuals do not make college decisions based on that deduction. Rather their decision to attend college is principally based on the expected benefit in the form of higher salaries and pursuit of career aspirations.

Other potential policy inefficiencies emanating from the tax code include using the Earned Income Tax Credit (EITC) to address poverty (but doing so using the number of children as the primary metric, rather than regional cost-of-living differentials); promoting tax rate differentials on capital gains and carried interest on the theory that they spurs investments when most of those gains emanate from secondary market transactions which tend to have a de minimis, or at best marginal, impact on business investments.

It is tempting for politicians who are stumping for political support to carve up the population into identifiable groups and target them with discreet policy prescriptions. However, rather than picking winning sectors the government would be better served eliminating all of these deductions and reducing the tax rates across the board. Then, if they’re interested in promoting individual sectors they can do so using non-tax sector-specific policies. Simplifying the tax code is good business for everyone as this will have the greatest stimulative impact on the economy.

Keith Thompson is a Senior Economist in Transfer Pricing with an agency within the US Department of the Treasury, and an adjunct Economics professor with Ramapo College of New Jersey.

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