The ‘Tax Expenditure’ Myth is a Serious Threat to Liberty

Does the state own your income and wealth prior to taxing it? Syracuse University political scientist Chris Faricy thinks so. Faricy, the author of a book titled “Welfare for the Wealthy,” distorts language in a way that would make George Orwell, author of 1984, cry out from the grave, “I told you so.” 1984 is the saga of a totalitarian collectivist state that uses language distortion—called “newspeak”—to solidify its powers. The purpose of newspeak is to undermine clear thinking, leading to a blurring of the distinction between opposing concepts. Hence, the state’s infamous political slogan  WAR IS PEACE, FREEDOM IS SLAVERY, and IGNORANCE IS STRENGTH.

Apparently believing that most Americans are ready for newspeak, Faricy now adds, A TAX BREAK IS A SUBSIDY. Faricy’s point is that tax breaks are really tax expenditures, which in turn amount to tax subsidies—i.e., money spent by the state. Since most of these “tax expenditures” go to people in upper income tax brackets, they must be classified as “welfare for the wealthy.”

In a question and answer with John Sides of the Washington Post, Faricy explains his position:

Q: The conventional wisdom is that the Democrats want to expand government and Republicans want to shrink it. But you argue “a vote for the Republican Party is not necessarily a vote for smaller government.” Why is that?

A:  The Republican Party is not immune from electoral pressures to use the federal government to benefit Republican constituencies. The main difference between Democrats and Republicans is not whether to spend federal money but rather who those constituencies are. For the GOP, two important groups are wealthier households and businesses. Republicans have pursued policies that benefit both — things like government subsidies for IRAs and Health Savings Accounts (HSAs).

Q: A key element of this more “private” welfare state is a tax expenditure. Can you define that briefly?

A:  Most people know tax expenditures by its informal name — a tax break. Budget experts and many policymakers, including Republicans such as (House Speaker) Paul Ryan, consider targeted tax breaks as being similar to actual government spending. Both tax expenditures and spending programs direct federal money to government-approved activities or groups. Both influence the private market by picking winners and losers, and increases in either one are ultimately paid for through higher taxes, lower spending for other programs, or increased borrowing. In 2015, the federal government spent over $1 trillion via tax breaks and the majority of that money went to social welfare programs.

Q: You argue that tax expenditures disproportionately benefit the wealthy and not the middle class or the poor. What are some examples of programs that do this?

A: One example is the collection of tax subsidies for private pensions. In 2015, the average household in the top 1 percent received pensions subsidies worth over $13,000 while the average benefit for a middle-class family was only $1,000. The main reason for this discrepancy is the progressive federal income tax structure. For example, if a high-income worker in the 39 percent bracket contributes $10,000 for her pension, she receives a subsidy of $3,900. If a lower-paid worker in the 10 percent bracket excludes the same $10,000 for her pension, the tax break is worth only $1,000.

Just to be certain of what Faricy is saying, Sides asks, “So because I have an employer sponsored 401(k) and health care plan, take the home mortgage interest deduction on my tax return, and save money for my kids’ college education in 529 accounts, I am a great illustration of what you’re talking about.”

Faricy answers, “Yes, you are a welfare queen.”

This turns reality, logic, and fairness on its head.

There is some truth to what Faricy is saying, in one respect. The politicians do manipulate the tax code through special provisions to incentivize private spending towards “government-approved activities or groups [and to] influence the private market by picking winners and losers.” It is not the proper purpose of a government to influence private behavior either through direct mandates or by influencing incentives through tax manipulation. That’s why I favor wiping out the current income tax in favor of a clean flat tax that wipes out special tax provisions in exchange for a single, much lower tax rate.

But Faricy is wrong to say the politicians are directing federal money. In fact, the money in question never leaves private hands. Productive citizens are given a choice of paying one tax rate or another, depending on whether they choose to put money into something that eliminates or defers taxes, or not. Since the federal government never takes possession of the money in question, it can not spend it. An example of a true tax expenditure is a government voucher, in which the government first takes possession of the money, then writes a check directly to someone. The key difference is who pays: If the government drops a $2000 payment into your IRA (Individual Retirement Account), that is a subsidy. If you deposit the $2000 into your IRA, you deposited your money. The fact that the government could have taxed that money away from you, but chose not to, is not a subsidy.

The action of a citizen to legally minimize his tax burden, such as by taking advantage of an IRA, Health Savings Accounts, and the Home Mortgage Interest deduction, does not amount to a subsidy. The taxpayer is simply paying the tax required of the government. The rest is money the citizen earned and is rightfully his. Keeping what you have earned is not welfare.

But think of the insidious premise that Faricy is sneaking in. Faricy is essentially saying that because the money you socked away in an IRA could have been taken by the government, it is a handout. But the same could be said of every dollar you earn. If that is the case, the government owns every dollar that every American earns. We have arrived at the ultimate inversion: Your earnings are not yours by right, but by privilege bestowed on you by government, since the government has first claim on its citizens’ wealth. Put another way, the government, which creates no wealth, is the owner of  all of the wealth of the people who do create the wealth.

This premise has serious negative implications for liberty, both short and long term.

In the short term, if the “tax expenditure” myth Faricy puts forward becomes widely accepted, it could lead to much higher taxes on productive Americans. Statists looking to reduce “welfare for the wealthy” can simply "sell" the elimination of various tax reduction policies—i.e., hiking taxes—as reducing redistribution of wealth. Faricy’s myth is a major threat to the budding school choice movement, which relies heavily on education tax credits to avoid violating the constitutional wall of separation between church and state precisely on the grounds that private individuals, not the state, are making the payments to private religious schools. The U.S. supreme Court has rejected First Amendment challenges to tax credit-based school choice programs, such as its 2011 decision rejecting the ACLU’s challenge to an Arizona program, precisely on the grounds that . . .

When Arizona taxpayers choose to contribute to [School Tuition Organizations], they spend their own money, not money the State has collected from respondents or from other taxpayers. . . . Like contributions that lead to charitable tax deductions, contributions yielding [School Tuition Organization] tax credits are not owed to the State and, in fact, pass directly from taxpayers to private organizations. Respondents’ contrary position assumes that income should be treated as if it were government property even if it has not come into the tax collector’s hands. That premise finds no basis in standing jurisprudence. . .

But the Supreme Court’s ruling was narrow—only 5-4—indicating how close we are to having the highest court implement Faricy’s fallacy across the economy. There are other reasons to favor tax credits for education, as I’ve noted in my Objective Standard article. All of them would be threatened.

In the area of fairness, Faricy doesn’t distinguish between a tax break and a tax deferral. Traditional IRAs, 401ks, and the like do not eliminate taxes; they just defer them (albeit allowing some taxpayers to theoretically pay taxes later at a slightly lower rate). More importantly, Faricy ignores the fact that “the wealthy” benefit the most from tax breaks because they pay the most in taxes, even after having their taxes reduced by tax deduction, credits, or deferrals. As The Tax Foundation reports, the lowest 50% of earners pay only 3% of all federal income taxes collected. The top 50% pay the rest, with the top 5% paying 57% of the federal government’s income tax take. Eliminating the alleged “welfare for the wealthy” would greatly increase that already draconian burden.

As bad as the short term implications of Faracy’s “tax expenditure” myth are, the long term implications are much worse. If it ever becomes legally accepted that the government has first claim on the nation’s wealth, by virtue of its taxing authority, we will all in effect become slaves living at the pleasure of the state—thus establishing a major foundational element of totalitarianism. We will all have lost our property rights to the product of our labor. By logical extension, we will have lost all of our freedoms, because whoever controls your material means of supporting your life has you by the throat.

Statists have a lot of newspeak in their linguistic arsenal. The tax expenditure myth is one of them. Beware.

Related Reading:

Time for a Flat Tax

Do Tax Credits Equate to a Government Subsidy?

Rather than Repeat the Mistakes of 1986, How About a Flat Tax?