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There Is No Neutral Tax: Lessons from the the Amazon HQ2 “Subsidy”

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Mises Wire Joseph T. Salerno
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Capitalism breathes through those loopholes . ~Ludwig von Mises1

I. Introduction

A little noted aspect of the media brouhaha that erupted in the wake of Amazon’s reneging on its deal to locate part of its headquarters in New York City was that almost all participants, pro or con, routinely referred to the tax breaks included in the deal as “government subsidies.” Given the abysmal state of economic knowledge prevailing in the mainstream media this was to be expected and is hardly worth noting. What is remarkable is that a great number of free-market economists and policy experts who wrote about the deal, before or after it collapsed, also treated the tax cuts as, in effect, government subsidies. Accordingly, they declared the deal to be economically inefficient and inequitable, reducing productivity and consumer welfare and transferring wealth from some firms and household to others. It is also noteworthy that most of the authors of these commentaries and policy papers were associated with well-known market-friendly think tanks such as the Cato Institute, the Mercatus Center, the American Enterprise Institute, the Independent Institute, the American Institute of Economic Research, the Manhattan Institute, and the Reason Foundation.2

This effusion of critical commentary on the Amazon deal from free-market proponents reveals an area of serious concern for those interested in disseminating the ideas of Austrian economics: Chicago price theory still exerts an iron grip on free-market thinking in the United States. Even many economists who profess to follow the Austrian tradition in the areas of money, central banking, and business cycles, default to Chicago theory when it comes to analyzing taxation and other areas of applied price theory. In particular, they accept the central premise of the Chicago school that taxes per se are not an intervention into the market economy, in contrast to price controls or government grants of monopoly privileges. The Chicago view implies that there exists a tax that is neutral to the market economy and does not distort relative prices and the allocation of resources and that this “neutral tax” can be identified by economists and implemented by government. In practical terms, the Chicagoan neutral tax boils down to the program outlined by Milton Friedman:

[A] flat-rate tax on income above an exemption, with income defined very broadly and deductions allowed only for strictly defined expenses of earning income. … [T]he abolition of the corporate income tax … with the requirement that corporations be required to attribute their income to stockholders, and that stockholders be required to include such sums on their tax returns. The most important other desirable changes are the elimination of percentage depletion on oil and other natural resources, the elimination of tax exemption of interest on state and local securities, the elimination of special treatment of capital gains, the co-ordination of income, estate, and gift taxes,and the elimination of numerous deductions now allowed.3 [Emphasis added]

Those free-market economists who follow Friedman down this road thus become, in effect if not intent, efficiency experts for the State. They evaluate every alteration in tax policy on the basis of whether the change represents a movement toward or away from the neutral tax ideal. But in doing so, they ignore another approach to price theory, the causal-realist approach of the Austrian school founded on the insights of Carl Menger. The contemporary followers of this approach reject the neutral tax as a myth and view taxation as a government intervention on the same footing with price controls and monopoly privileges.4

In the next section, I outline the basic principles of government finance from an Austrian causal-realist perspective with emphasis on their implications for the effect of targeted tax cuts on economic efficiency and social welfare. In the third section, I use these principles to resolve the question of whether the Amazon HQ2 deal was an instance of crony capitalism or a concrete move toward a more voluntary and efficient allocation of resources.

II. Fundamental Principles of Government Finance

1. The very existence of taxation creates two classes in the economy. To one class belong the taxpayers, who earn their income through voluntary production and exchange on the market. The second class comprises the tax-consumers, especially the full-time politicians and bureaucrats who run the State apparatus and whose salaries derive from taxes. The latter class also includes those whom the government either procures goods and services from, i.e., government contractors, or funnels subsidies to via corporate bailouts, loan guarantees, agricultural programs, or social welfare payments. Needless to say, because taxes are inherently coercive, taxpayers are made demonstrably worse off by the tax-and-expenditure process while the tax-consuming class reaps the benefits.

2. Despite the fact that some people in the economy may simultaneously pay taxes and receive subsidies, everyone in the economy must be either a net taxpayer or a net tax-consumer to one degree or another. Politicians and bureaucrats as proprietors of the government apparatus are of course pure tax consumers who pay no taxes. The taxes they nominally pay on their incomes are merely an accounting fiction designed to mislead taxpayers. In many cases, however, only investigation of the concrete data can reveal whether a particular person or organization is benefited or victimized by the tax-expenditure process. Take, for example, a cloud computing company that receives its revenue from both voluntary purchases on the market and government procurement contracts. Only by perusing its income statement can we ascertain whether the firm was a net taxpayer or tax-consumer for a given time period.

3. There is, thus, a sharp distinction between a tax cut, break, loophole, deduction, exemption, credit, abatement—or whatever else it may be called—and a subsidy. A tax cut occurs whenever a lower proportion of income or wealth than previously is forcibly extracted by government from someone who has earned it through voluntary production and exchange. A subsidy occurs when Peter the producer is taxed and—after a cut is taken by the administrative bureaucracy—the remaining funds are subsequently transferred to Paul, who may be a failing financial institution, military contractor, or welfare recipient. A tax break therefore reduces the amount of income siphoned off from net taxpayers who worked, invested, or bore entrepreneurial risks to earn it, while a subsidy bestows unearned goodies on parasitic net tax-consumers favored by the government. In short, a tax cut allows someone to retain more of his own money and a subsidy gives someone more of someone else’s money. As Rothbard put it:

[A]n exemption from taxation or any other burden is not equivalent to a subsidy. There is a key difference. In the latter case a man is receiving a special grant of privilege wrested from his fellow men; in the former he is escaping a burden imposed on his fellowmen. Whereas one is done at the expense of his fellowmen the other is not.5

4. Although the concepts are theoretically clear and definite, a tax break or a subsidy cannot be identified in practice unless one knows the class to which the recipient belongs. For example, it is impossible to cut the taxes of a military contracting firm who sells all of its output to the Federal government, because it is a tax-consumer to begin with and pays no taxes. In this case, a cut in its corporate income tax rate is tantamount to a subsidy. Conversely, net taxpayers cannot be subsidized. Vouchers given to parents of parochial school children for public transportation, although nominally subsidies, are in most cases a de facto tax rebate that allows those working and investing to serve consumers in the private sector to keep a little more of their own income.6

5. There is no such thing as a neutral tax, that is, a tax which leaves undisturbed the price structure, allocation of resources, and income distribution determined by the unhampered market. The fundamental reason for this is that taxation cannot be analyzed in isolation from government expenditure. As noted above, the imposition of taxes inexorably brings into existence a tax-consuming class, including the entire government apparatus itself, whose structure of demands for goods and services inevitably differ from that of taxpayers. No matter what their form or whom they are levied on, taxes therefore must always distort prices, production, and incomes away from the pattern that would emerge on a pure market governed by consumer sovereignty. Furthermore, market forces inevitably shift part of the tax burden from the households or firms who are legally obligated to pay a particular tax to others in the economy and thereby determine the ultimate “incidence of taxation.” It is utterly impossible, therefore, for the economist or anyone else to know or predict what the optimal pattern of resource allocation would be on the unhampered market, let alone concoct a neutral tax program that would approximate this ideal.

6. Although the (ever changing) state of resource allocation that best serves consumers, therefore, can never be determined in the absence of a market free of the predatory tax-and-expenditure process, causal-realist economic theory enables us to judge movements toward or away from the ideal state. A cut in taxes, whatever its form or amount, will always improve resource allocation and the satisfaction of the most urgent demands of (taxpaying) consumers; and the larger the tax cut, the bigger the improvement. This is so because cutting taxes releases resources from the wasteful government sector, including the tax consuming recipients of its contracts and subsidies, back to productive taxpayers, whose labor and capital are more efficiently allocated according to the profit calculations of private entrepreneurs.

7. It thus follows that a tax cut of a given size cannot be judged more or less efficient than a tax reduction of equal size that takes a different form and impacts different taxpayers. Let us compare, for example, an exemption of the entire U.S. oil and gas industry from the corporate income tax with an across the board reduction in marginal tax rates on personal income. Assume that both policies result in an equal reduction in Federal tax revenues. The two tax cuts will have entirely different price, allocation, and distribution effects. But since no one, including the economist, knows the optimal resource allocation absent an unhampered and untaxed market, it would be impossible to scientifically determine which tax cut is more efficient. All that the economist can state with scientific exactitude is that both tax cuts improve social utility or welfare because they free up additional resources to be consumed or invested in accordance with consumer sovereignty.

The economist, however, can also assert that, irrespective of the details of its kind and scope, a larger tax cut is always more efficient than a smaller one because it moves the economy farther in the direction of the optimal allocation of resources. This principle can be demonstrated by considering the largest conceivable tax cut: the complete abolition of taxes and the consequent liquidation of the tax-consuming class. In this case, the pricing and allocation of resources and the quantities, qualities, and prices of consumer goods produced are fully and exclusively determined by the value scales and demands of “productive” consumers as forecast and appraised by profit seeking entrepreneurs. From this, we see that the existence of a tax-consuming class, however small, distorts market allocation of resources.

8. Now, many free-market economists will object to the contention that it is the amount and not the form or distribution of the tax cut that matters in judging its economic efficiency by appealing to a long entrenched maxim of taxation. This is the principle of equality of treatment, which states “equals should be treated equally.” For example, given a progressive income tax, every person with equal income should pay an equal percentage of his income in taxes. But there are two fundamental flaws in this maxim. First, the principle of equal treatment glosses over the question of whether the treatment itself is just or efficient. Surely no economist today would assert that it is unjust or inefficient to exempt one individual among a group of persons who have been enslaved from performing the same number of hours of forced labor required of everyone else. Second, the principle of equal treatment is self-contradictory when applied to taxation. For, as noted, taxation brings into being a class of tax-consumers. This class can never be treated equally with taxpayers, precisely because they do not pay taxes. Politicians and government bureaucrats live off the taxes they mulct from the taxpayers.

9. Another argument that is often made by free-market economists against tax cuts that “unequally” benefit selected households, corporations, or industries is that it forces other taxpayers to “foot the bill” for the discriminatory tax cut. This argument rests on the implicit premise that government must collect a certain amount of taxes from its subjects, that everyone is somehow allotted a “fair share” of this tax burden, and that anyone paying less than his fair share means that someone else must pay more than his fair share. The argument is nonsense on stilts and is open to several objections. First, it assumes without argument that taxation per se can be fair or efficient. Second, it makes the even more dubious assumption that the distribution of the tax burden under the status quo is fair or efficient, or at least more so than that which would emerge as a result of the targeted tax cuts. Yet, as we saw, economic science can shed no light on the most efficient method of allocating a given tax burden among taxpayers; it can only tell us that a cut in the total amount of taxes extracted increases productive efficiency and enhances social utility. Third—and most important—the argument completely leaves tax-consumers out of account. Why not finance the tax cut by a reduction in government expenditures on the employment and salaries of bureaucrats, purchases from military contractors, or transfers to subsidized constituencies?

10. Market-oriented economists almost universally lament the waste of resources that results from the lobbying activities of taxpayers seeking targeted tax breaks. These “rent-seekers” pay lobbyists, lawyers, and accountants to secure and exploit tax loopholes granted by politicians. The resources absorbed by these activities allegedly represent a pure waste because they could have been used to produce valuable goods and services. But here the argument requires a leap of logic because these resources would not have been used to produce goods and services most highly valued by productive consumers but instead would have been squandered by tax-consumers. So if taxpayers succeed in obtaining net tax reductions—no matter how small—their costly lobbying activities are productive of more efficient resource allocation and greater social utility. In fact, lobbying for tax cuts is as economically productive as individual taxpayers hiring lawyers and accountants to help find and exploit existing tax loopholes

In criticizing the plan to close all tax loopholes by imposing a flat tax in order to avoid resource costs of complexity, Murray Rothbard pointed out:

[Those] who struggle with complex forms are doing so for a good reason: to pay less taxes. … [T]here is … a good reason for our paying money to tax lawyers and accountants. Spending money on them is no more a social waste than our purchase of locks, safes, or fences. If there were no crime, expenditure on such safety measures would be a waste, but there is crime. Similarly, we pay money to the lawyers and accountants because, like fences or locks, they are our defense, our shield and buckler, against the tax man. … [T]he way to get rid of tax lawyers and accountants is to abolish the income tax. That would be Sweet Simplicity indeed!7

11. Recently, free-market advocates have singled out for special criticism “targeted” tax cuts designed to induce a particular corporation to move some or all of its operations to a city or state with the aim of generating more jobs, higher incomes, revitalized downtown areas, etc. They argue that these cuts are inefficient because empirical studies show that they seldom accomplish their intended objectives and are of little benefit to taxpayers in the political jurisdiction granting them. There is no reason to debate these empirical findings. For the flaw in this argument is the failure to recognize that a regional economy is always a part of a larger, interconnected national or global economy and that, even if most of the direct benefits accrue to firms and consumers in other political jurisdictions, the tax cut still enhances economy-wide efficiency and welfare.

Furthermore, indirect benefits may well flow to taxpayers in the city or state granting the tax incentive via another channel. All tax reductions, whether broad-based or selective, reduce social time preferences and increase saving, investment, and labor productivity throughout the economy. The reason is that a larger proportion of social income is retained by the productive, taxpaying class and fewer resources are siphoned off into consumption or malinvestment by government purchases and subsidies. Their increased after-tax incomes induce taxpayers to lower their consumption/saving or “time” preferences and save a larger proportion of their earnings. These additional savings are allocated by capital markets to private entrepreneurs who seek to invest productively in building up the social capital structure using some of the resources previously malinvested or consumed by government and its subsidized cronies and favored constituencies.

More important, the perceived success of targeted tax breaks in the last few decades has spurred competition among rival political jurisdictions in the U.S. to create ever larger, broader, and more creative tax cuts and loopholes. Instead of bemoaning these tax cuts as somehow suboptimal relative to a mythical standard of tax neutrality, free-market economists should be applauding the proliferation and widening of tax loopholes as a practical and politically palatable means for moving toward the only truly “neutral” financing regime for all goods and services, namely, the free market itself. Indeed, lobbying by special interest groups for discriminatory tax cuts may be the most feasible method of rolling back taxes precisely because, as Public Choice economists never tire of reminding us, the benefits of the cuts are concentrated on a small group while the costs are spread out over the large group of tax-consumers feeding at the public trough. Thus, in the case of tax cuts, Public Choice economics is stood on its head and “rent-seeking,” that is, investing resources to lobby for tax breaks, enhances economic efficiency and social welfare.

In the 1980s, Rothbard welcomed an all-out war for selective tax breaks among special interest groups and touted it as a viable tactic for rolling back overall taxes. In advocating the revival of a targeted tax credit for child care services and widening it to apply to mothers tending their children at home, Rothbard wrote:

Let us hope that the tax credit will return in full force. And that we can revive the lost tactic, not of “closing the loopholes,” but of ever widening them, opening them so widely for all indeed, that everyone will be able to drive a Mack truck through them, until that wondrous day when the entire Federal revenue system will be one gigantic loophole.8

III. Amazon HQ2 Deal: Yea or Nay

Were the free-market opponents of the Amazon HQ2 deal correct in portraying it as an example of crony capitalism writ large, which victimized consumers and competitors and lowered economic efficiency? In light of the principles of Austrian public finance set out above, my answer is a resounding “No.” A close examination of the details of the deal makes it plain that the “targeted incentives” that Amazon was due to receive from state and city authorities were genuine tax breaks and not subsidies.

To confirm this, let us enumerate the amount and nature of the benefits promised by the political authorities to Amazon in exchange for situating part of its headquarters in the Long Island City section of Queens, New York. Amazon was to receive a total of up to $2.9 billion over 25 years from New York State and New York City broken down as follows:

  • $1.2 billion of refundable tax credits under New York State’s Excelsior Jobs Program awarded on a rolling basis over 10 years.
  • $505 million in a capital grant from the state, paid out over 10 to 15 years to reimburse Amazon for building office space.
  • $827 million worth of business income-tax credits over 25 years from New York City’s Relocation and Employment Assistance Program (REAP).
  • $387 million of property tax breaks over 25 years under the city’s Industrial & Commercial Abatement Program (ICAP).

It is worth noting that the city tax breaks were to be disbursed to Amazon under “as-of-right” programs, REAP and ICAP, already in existence and available to any business that meets their requirements. Amazon was also eligible to receive additional tax breaks because the prospective site of HQ2 in Long Island City had been designated as an “opportunity zone” by the Tax Cuts and Jobs Act signed into law by President Trump last year. Thus Amazon did not have to engage in the dastardly deed of “rent-seeking” to obtain the $1.2 billion plus of city tax credits, although there were undoubtedly costs of compliance. The crucial point, however, is that Amazon would have remained a net taxpayer despite its $3 billion of tax incentives, because, according to New York state estimates, Amazon would have paid $27.5 billion in net taxes during the 25-year duration of the tax incentive program it was promised.9

Based on sound Austrian economic theory, we may conclude, then, that the Amazon deal, had it been implemented, would have been a definite move toward the actual free-market allocation of resources thereby improving economic efficiency and enhancing social welfare. Unfortunately, the insidious myth of neutral taxation misled a passel of free-market thinkers, including some sympathetic to Austrian economics, into believing otherwise.

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