Current deficit reduction talks are reported to have “everything on the table” – all income sources and all outlays. The least agreement swirls around income tax revenues, both in the scope of taxation and the tax rates. Personal exemptions from federal tax application include items such as charitable donations, mortgage interest, and state and local taxes paid. Tax exemptions also apply to not-for-profit entities.
Concessions in tax rates apply to activities – such as deduction timing for capital expenditures, and lower rates for capital gains than for other income. Exemptions and rate concessions were adopted by legislators who knew that they are beneficial to the public, but in times of political budget strife, kleptocrats want to label them “tax expenditures” – cynical name-calling that implies the funds belong to the government. They don’t.
Deceptive labeling may help style the intended money-grab as less damaging, but repeal of exemptions can cause serious harm to the public. Exemptions and rate concessions are deep-seated, powerful factors in shaping the consumers’ and businesses’ economic behavior such as; buying a home, interactions with nonprofits, building or updating a factory, providing health coverage, or buying vehicles (even a corporate jet). Many jobs are molded around the contours of the tax system.
One example is the mortgage interest deduction. The prospect of deducting mortgage interest has helped most consumers buy their first home, or a home that’s a little bigger or nicer than could be afforded without the deduction. The resulting boost to jobs in construction, furniture, finance, and municipal services is understood.
There are less obvious examples. Take for example the tax exempt status of credit unions, which allows consumer members to benefit by $6 to $7 billion per year more (higher deposit interest and lower loan rates) than they would at retail banks. In buoyant times, their benefit would be $10 to $12 billion. If federal taxes were applied, credit unions would pay taxes of $0.5 to $1 billion now, or $1.5 billion in normal times. Removing the tax exempt status would cause credit unions to “demutualize”, i.e. become for-profit stock companies, reducing them to the same behavioral segment as retail banks, and the member benefits would dissipate. The federal tax gain of $1.5 billion would cost consumer members $11 billion yearly – a horrifically bad decision.
Tax exemptions are not uniformly good or bad. Before tossing a bushel of “tax expenditures” on the negotiating table, consumers deserve a competent study of the economic impact of removing each exemption.
Alan Daley is a retired businessman living in Florida. He follows public policy issues from the consumer’s perspective