In a recent Mises Daily I argued against the widespread belief that tax breaks are a kind of subsidy. This proved to be a controversial topic, so I’d like to clarify the basic argument, as well as raise some additional criticisms.
In some ways it makes sense that people conflate tax exemptions and subsidies, because both are inextricably tied up with the culture of privilege-seeking that is politics. My original article, for example, observed that the video game industry combines several kinds of benefits, including tax exemptions, public loans, and intellectual property protection. My point was that although these policies might appear similar, they actually have different economic implications.
When economists argue that exemptions aren’t subsidies, we mean that exemptions don’t in and of themselves cause distortions in the economy; rather, distortions are due to the fact that once exemptions are granted, any remaining taxes have different relative effects. In other words, tax breaks don’t create unfair advantages—rather, taxes create unfair disadvantages. This means that when entrepreneurs fail because they can’t find a loophole, the real problem is their own high taxes, not other entrepreneurs’ exemptions.
Some commenters rightly point out that tax breaks lower government revenue and encourage either raising taxes or creating new ones to offset the loss. As before though, the fundamental problem is government’s ability to tax, along with the assumption that it should be offsetting lower revenue to begin with.
Tax policy rhetoric assumes government has first claim to the taxpayer’s income. This premise is used to transform traditional arguments against taxation into arguments against reducing it. The New York Times, for example, warns that exemptions are dangerous because “it’s a lot easier to create a tax break than to eliminate it”!
Now, granting exemptions only to certain producers is not an ideal solution, and often involves favoritism. Yet it is still an improvement compared to higher taxes for all producers. Lower taxes at least open the door for some entrepreneurs hoping to serve consumers: higher taxes slam it shut, and subsidies bulldoze the building.
Yet while the tax break myth causes enough trouble by itself, it’s also symptomatic of a larger problem—the way political rhetoric distorts economic ideas.
It’s no surprise that tax policy debates are full of misleading language; after all, taxation is a defining characteristic of governments, who need help selling it to the general public. As a result, policy analysts are constantly pouring the old tax wine into new rhetorical bottles—to prevent people realizing it’s actually vinegar.
The tax exemption story is a good example. The real danger of this myth is that it contains a grain of truth: the notion that subsidies unfairly stifle competition and hurt consumers. Conflating lower taxes with subsidies thus leads people to believe that keeping more of their income will have similar consequences. From there, it’s a short step to thinking of lower taxes as inefficient and immoral.
Even worse, equating exemptions with subsidies doesn’t just criminalize lower taxes: it can also legitimize subsidies. Conflation puts the worst rent-seekers in roughly the same category as honest entrepreneurs trying to keep their hard-earned money. It therefore undercuts criticism of subsidies by implying everyone gets them.
This in turn reinforces the idea of government as impartial referee in the economy: if it’s assumed everyone is subsidized, all that’s left is for government to determine how the subsidies should be distributed to achieve the best social outcome. Once government takes on this role, attention shifts from asking whether subsidies should exist at all, to fighting over who will receive the greater share. By blaming tax breaks, the exemption myth turns taxpayers against each other instead of focusing their attention on taxation itself.
Moreover, bad rhetoric not only confuses the basic problem, but also undermines real solutions—like the elimination of taxation and protectionism. (Remember, if tax breaks are really a kind of subsidy, we can eliminate them by raising everyone’s taxes.)
It’s important to realize that this discussion covers only one misconception about one area of government activity. There are countless other examples we could point to, especially relating to the spending side of government operations. A great example is the periodic panic about “drastic cuts” in the federal budget, which always turn out to be massive increases. But of course, we’re unlikely to hear much on the true level of government spending, because that wouldn’t support convenient narratives about a “culture of austerity” (we should be so lucky!) or “neoliberalism.”
Everyone knows governments misuse language in order to promote their own interests. Still, it’s hard to keep track of every subtle manipulation, especially when they come packaged with otherwise sound criticisms. Myths about taxation are just one reason we need good economics now more than ever.
