Tag Archives: tax expenditures

Corporate welfare spending is not transparent

Over a century ago, the Italian political economist Amilcare Puviani suggested that policy makers have a strong incentive to obscure the cost of government. Known as “fiscal illusion,” the idea is that voters will be willing to spend more money on government if they think its costs is lower than it actually is. Fiscal illusion explains a great deal of public choices, including the popularity of deficit spending.

It also explains why the public knows the least about some of the most controversial items in the public budget such as corporate welfare. But some would like to change this. Here are Jess Fields and Tom “Smitty” Smith, writing in the (subscription required) Austin-American Statesman:

Texans believe in government transparency and accountability. For this reason, we have some of the most advanced open-government initiatives in the nation. Yet one policy area remains outside the view of the general public: economic development.

When local governments cut deals that result in millions in incentives, they can do it behind closed doors in “executive session” — legally — thanks to exceptions to the Open Meetings and Public Information Acts for “economic development negotiations.”

Fields is a senior policy analyst at the free enterprise Texas Public Policy Foundation, while Smith is the director of the Texas office of Public Citizen, a progressive consumer advocacy group started by Ralph Nader in the ‘70s.

Texans aren’t the only ones interested in making corporate welfare more transparent. The Government Accounting Standards Board (GASB) is considering rules that would require governments to report the tax privileges that they hand out to businesses. Here is Liz Farmer, writing in Governing Magazine:

Specifically, GASB is proposing that state and local governments disclose information about property and other tax abatement agreements in their annual financial statements. If approved, the new disclosures could shed light on an area of government finance and provide hard data on information that is assembled sporadically, if at all. Scores of public and private groups support the proposal and it has proven to be one of GASB’s most debated topic yet, as nearly 300 groups or individuals submitted comment letters to the board. But many still say the requirements don’t go far enough.

She notes that the proposal misses a number of tax privileges including:

  • Tax increment financing (TIF),
  • Agreements to discount personal income taxes,
  • “[P]rograms that reduce the tax liabilities of businesses or similar classes of taxpayers.”

Because of these omissions the new GASB rules may only capture about one-third of all tax expenditures.

Puviani would have predicted that.

The Home Mortgage Interest Deduction: A Bad Deal for Taxpayers

A new policy brief released by the Mercatus Center and co-authored by Jeremy Horpedahl and Harrison Searles analyzes one of the most popular—and therefore one of the most difficult to reform—subsidies in the tax code: the home mortgage interest deduction. This study touches on many of the points that Emily talked about in her op-ed on the subject last month; namely, this policy’s failure to achieve its intended effects and the fact that a lion’s share of the benefits go to high-income homeowners. Despite widespread enthusiasm for the home mortgage interest deduction, the authors argue that the benefits of this policy are overstated and the consequences are understated.

The home mortgage interest deduction is one of the largest tax expenditures in the U.S. tax code, second only to the non-taxation of employer-provided health insurance and pension contributions. Proponents of the home mortgage interest deduction argue that this policy provides needed tax relief to the middle class and encourages the oft-invoked American dream of homeownership. These folks may be surprised to learn, as Horpedahl and Searles point out, that a mere 21.7% of taxpayers even claim this benefit. What’s more, most of these benefits don’t go to the middle class, but rather to households with incomes of over $200,000. Here’s a breakdown of the tax savings from the brief:


The claim that this policy is necessary to encourage home ownership is dubious as well. The authors explain:

Empirical evidence supports the claim that the mortgage interest deduction has little effect on homeownership rates in the United States. Between 1960 and 1997, homeownership rates stayed within a narrow range of 62 to 66 percent, despite the fact that the implicit tax subsidy fluctuated dramatically. During the recent housing bubble, the homeownership rate rose to 69 percent, but it has since returned to the historical range. This rise appears to have been unrelated to the mortgage interest deduction, though it was almost certainly related to other housing policies that encouraged the bubble. More sophisticated analysis suggests that the homeownership rate would be modestly lower without the deduction, by around 0.4 percent.

Ironically, the home mortgage interest deduction likely creates the perverse effect of discouraging homeownership by artificially raising home values. Economic intuition suggests, and empirical studies have supported, that the deduction does not provide much in the way of savings at all since the value of the deduction is simply capitalized into the value of home prices. The artificially higher house prices prevent would-be home owners on the margins of affordability from purchasing a home within their price range. This effect, combined with the low rates of deduction claims and concentration of benefits to high-income earners, likely contributes to the inefficacy of the home mortgage interest deduction to boost homeownership to the degree that its proponents envisioned.

Additionally, countries like Canada and Australia have managed to produce comparable rates of home ownership as the US without the crutch of a mortgage interest deduction.

While the home mortgage interest deduction doesn’t do much for increasing the number of houses, it has a knack for increasing the size of houses, as a study by Lori Taylor of the Federal Reserve Bank of Dallas pointed out. The deduction has had the unintended consequence of directing capital and labor to high-income residential housing projects that might not have been taken without government intervention—and the benefits overwhelmingly go to the wealthy.

This is all before considering the regressive effects of the policy by design: low- and middle-income renters are made to subsidize the increasingly opulent residences (and sometimes the extra vacation homes!) of their more well-off peers while they struggle to make ends meet in a sometimes-inhospitable economy. This injustice, combined with the inefficacy of the tax deduction to increase homeownership in any meaningful way, causes the justifications for the mortgage interest deduction to grow scarce.

In fact, it is becoming increasingly clear that this policy, which evaded the fate of its similar counterpart—the credit card interest deduction—during the tax fight of 1986, continues as law not because of good economics but because of bad political incentives.

Horpedahl and Searles offer three proposals for scaling back the home mortgage interest deduction: policymakers could 1) eliminate the deduction entirely, 2) eliminate the deduction while simultaneously lowering marginal income tax rates to compensate for the virtual tax increase, or 3) stop the deduction and replace it with a tax credit that taxpayers could redeem upon purchase of their first house. Horpedahl and Searles demonstrate that while this deduction is popular with the public and the real estate industry, it is simply a bad deal for most taxpayers.