“Tax Expenditures”: Old Vinegar Rebottled

The late management guru Peter Drucker noted decades ago that the notion of tax “loopholes” implies that government is the primary claimant to the entirety of its citizens’ income. The government’s claim is rendered less than absolute in practice only by glitches (intended or otherwise) in the tax code.

Enter now, stage left, the macroeconomics guru Martin Feldstein of Harvard, whose recent characterization of loopholes as “tax expenditures” has gained political currency. Feldstein argues that every tax “preference”—­ the relatively low tax rate on capital gains and qualified dividends income, for example—is constructively a government expenditure. Accordingly, if government is to solve the debt/deficit problem by cutting expenditures, then it can and probably should start by cutting in this area first. The practical effect of Feldstein’s argument is that Keynesian liberals can join (albeit disingenuously) with fiscal conservatives in demanding “expenditure” cuts. The end result, of course, would be increased government revenues.

Feldstein’s sophistry improperly conflates inflows with outflows. By his lights, any effective tax rate short of 100% entails a cuttable “tax expenditure.” This is palpable nonsense unless government in fact were the primary claimant to the fruits of every citizen’s effort and sacrifice. However, nothing in law, history, or common sense suggests that a truly democratic government could ever find itself in this exalted position.

Political demagoguery nevertheless will elevate Feldstein’s sophistry to the status of “truth” if his rhetorical ploy succeeds, which it ought not do. All proposals to increase government revenues can and should be defended honestly and on their merits.

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