The problem with ideological partisanship is that when people get too used to lining up behind one idea or another, they lose track of what principles led them to espouse the idea in the first place. Notwithstanding President Obama's exhortation against outdated partisan battles, everyone is still talking about tax cuts vs spending increases. The distinction between the two is far less than it appears.

In the same comments thread I quoted from yesterday, someone brought up the topic of "MetroChecks". I don't know what city he lives in, but every big city has a program like this. The MetroChecks are vouchers which can be spent on various sorts of mass transit. I got similar vouchers when I worked in San Francisco. When I lived in Alameda I used them to buy my monthly bus pass, and when I was in Rockridge I used them to buy high-value BART tickets. Employers give these vouchers to employees as a fringe benefit. I suppose Daschle's car brought them to the commenter's mind, prompting him to observe that no one reports those vouchers on their taxes.

They're not supposed to. The vouchers are tax-free, which is exactly why so many employers give them out. For every $100 on your paycheck, your employer has to pay $7.65 to the IRS for FICA and Medicare. Additionally he must withhold the same amount from your check as well as whatever you chose for withholding of regular income tax, maybe about $15. The result is that it costs the employer $107.65 to compensate you by $77.35.

If your employer gives you a transit voucher for $100, it costs him only marginally more than $100, and if you ride the bus or train to work anyway, it's worth only marginally less than $100 to you. Everybody wins. If your employer could pay your entire wages like this, he would. But he can't. By default, fringe benefits (like Daschle's car) count as taxable income. These vouchers do not because there is a special section in the Tax Code exempting them (section 132(f)). It lays out rules for what sort of transportation qualifies for the program, and it imposes a limit of $100 per month per employee.

It's easy to imagine how this program came about. Somebody wanted to use the federal government to increase ridership on mass transit. Of the various ways that might be effected, this is a fairly easy one to implement. No new bureaucracy is required. The tweak in the tax code creates an incentive for employers, someone will step in to meet the need (for a small fee), and the federal government pays for it in the form of reduced revenues.

How effective the program is in achieving its goal is hard to determine. An employer in a low-traffic suburb, like my current employer, would never subscribe. His six employees all drive to work. Riding the bus would be impractical, and none of us would do it even if it were completely free. For him to pay us in vouchers would be a waste of money, so he doesn't. The program has no effect on him.

The last regular day job I had was in downtown San Francisco. Nobody who works in downtown San Francisco drives to work unless they're rich or crazy. That employer paid us transit vouchers, and we all used them. I suspect that every employee there (about 12, though it varied over the years) would have taken public transit even without the voucher, so while we did all participate in the program, I'm not sure it had any effect on changing anyone's habits.

But presumably there are in-between cases where the vouchers make the difference for employees with a marginal decision to make.

In the Reagan era, when "supply-side economists" made the case for reducing taxes, the argument was that it would benefit the economy. These people were called "free-market conservatives" because they were conservatives who believed in the efficacy of the free market. In terms of serving progress, they believed, the free market could be expected to allocate resources more efficiently than could government.

Their logic on taxes goes something like this: If the government takes $1 zillion from the citizenry and spends that same $1 zillion on various programs to benefit that citizenry, the government will have allocated those resources. If the government cuts those programs and reduces taxes accordingly, then the people have $1 zillion less in government programs but they also keep $1 zillion more money in taxes which they can then spend how they choose.

Reality is always messier than theory, and undoubtedly many politicians and voters had many other reasons for supporting a reduction in government, but the pure economic rationale was this: if you suppose that the free market is a better allocator of resources than the government, you can achieve better results by reducing taxes and public spending. Free-market conservatives (and others with different motives who wished to hide behind a respectable argument) thus favored tax cuts and opposed public spending. Twenty-five years later, they still do, though many have forgotten why.

Today we're seeing the exact same reasoning applied in reverse. In the context of what to do to stimulate the economy, liberals and conservatives are once again arguing between raising spending and cutting taxes, only now the pro-spending liberals seem to have the upper hand. According to basic Keynesian theory, increasing government spending will stimulate the economy more effectively than cutting taxes.

The reasoning here is exactly the same, the only thing that has changed is the premise: where the free-market conservatives argued that the free market is better at allocating resources than the government, the Keynesians are saying that in the current situation the opposite is true. In this extended recession the market is not allocating resources well, and that's why the government needs to step in and forcefully reallocate them to something better. With the wrong kind of stimulus, people might just choose to keep their money rather than spend it. (How it should be that, in a recession triggered in large part by lack of savings, for the people to save more money would be a bad thing is an interesting question which perhaps I'll address some day.) Our stimulus package needs to consist of specific spending programs because otherwise we're letting the market decide, and the market is less smart than the government right now. The whole point of the stimulus is to take control away from the market.

Thus we have the same old debate about taxes vs spending but in a completely new context.

What people on both sides of this debate are missing is that, whichever premise you subscribe to, the reasoning that follows is flawed. It is flawed because the distinction between tax cuts and spending increases are so muddied that they no longer correspond neatly with the free market against the government.

Consider the transit voucher program. That program decreases government revenues and does not increase government expenditures. Therefore it counts as a tax cut. According to the rationale of the tax-vs-spend argument, that means it empowers the market at the expense of the government. Does it? No, it does not. Indeed, the whole point of the program is for the government to wrest control away from the market. Too many people were choosing to spend their own money by driving to work, so we chose to use government muscle to coax them into buses and trains. If a free-market conservative supported this program on grounds that it's a tax cut, he was betraying his alleged free-market principles.

One of the new goodies on this year's tax return is a first-time homebuyer's credit. If you buy a home between April 2008 and July 2009, and this home meets the definition of first home as spelled out in the tax rules ("first" is something of a misnomer there...), the IRS will reduce your tax bill by up to $7,500. There is a small catch, however. The IRS will then increase your taxes by $500 per year for the next 15 years, so it's not quite as good as free money, but it's still a 15-year interest-free loan from the government, which is good for something.

This, too, reduces revenue for the government without increasing spending, so it too counts as a tax cut. According to the rational of the tax-vs-spend argument, that means it fails to stimulate the economy. Does it fail? No, it does not. This program gets excellent stimulus return on the dollar because one has to buy a house in order to get the credit. Again, the whole point of the program is to coax people to buy what they otherwise wouldn't. Too many people were choosing to save their money instead of spending it in a scary housing market, so we chose to use the government muscle to coax them into buying anyway. If a Keynesian liberal opposed this program on grounds that it's a tax cut, he was betraying his alleged Keynesian principles.

One could list dozens more examples. Well, one in the tax business could anyway.... There are tons of targeted tax incentives stinking up the Tax Code, some very narrow, like the credit for buying a hybrid car; others very broad, like the home mortgage interest deduction.

The problem here is that we routinely define "tax cut" as anything that reduces government revenues, and "spending" as anything that increases government expenditures. The correlation of this with whether allocation of resources lies more with the free market or with the government is imperfect. Indeed, to the extent that political pressures reward government programs that can be labeled "tax cuts", that correlation is being actively eroded.

The solution is to let go of the phony distinction between "spending" and "tax cut" and look specifically at whether a program entails government allocation of resources. There's a huge difference between targeted tax cuts and untargeted tax cuts.

The latest Senate stimulus bill includes a provision sponsored by former real estate agent Sen Johnny Isakson (R, Ga.) which would double the homebuyer's credit while extending it all homebuyers without any means test or "first" requirement. Another provision, sponsored by Sen Barbara Mikulski (D, Md.) would allow a tax deduction for sales tax and interest payments on any car purchased this year. Both of these are tax cuts, but both involve the government aggressively directing the market. Any free-market conservative who still believes the market knows best has no business supporting these on grounds that they are "tax cuts". Likewise, any traditional liberal who insists that tax cuts are less stimulative than spending has no business opposing them on those grounds.

Compare these to non-targeted tax cuts. Economist Greg Mankiw advocates an "immediate and permanent" reduction of the payroll tax. New Jersey Sen Bob Menendez made sure that the Senate's bill contained an "AMT patch", the annual ritual by which the alternative minimum tax, designed to limit the deductions available to upper-income taxpayers, is "temporarily" held at bay for another year. (Curiously, the tax cut supported by Menendez, a Democrat, benefits the upper middle class, while the the proposal by Mankiw, known as a conservative, would give most benefit to the working poor.) Whatever other merits or demerits these two proposals may have, both would return huge amounts of resources to the public, therefore empowering the market rather than the government. These tax cuts, unlike Isakson's and Mikulski's, are thus vulnerable to the charge that they are less effective dollar per dollar as a stimulus. (Mankiw acknowledges this, but argues that other considerations compensate for that.)

I would suggest that any discussion that draws a bright-line distinction between tax cuts and spending while ignoring the difference between different types of tax cuts as these is due more to knee-jerk traditional political alignment than any sound economic rationale.

11:50:40 PM  [permalink]  comment []