Friday, April 27, 2012
This note argues that tradable tax credits offer advantages as compared to other mechanisms the federal government can use to affect social and economic policy. Policymakers should consider the tradable tax credit as a potentially desirable form of tax incentive, rather than a necessity of political compromise as was the case in the enactment of existing tradable credits. First, the note establishes that tradable tax credits can be the economic equivalent of direct spending programs and of refundable tax credits. Next, the note examines a limited but significant set of circumstances in which the tradable tax credit can offer efficiency and political benefits as compared to refundable tax credits or direct subsidies. The note creates a simplified example that illuminates how tradable tax credits can be beneficial, considering various forms of government intervention to prompt private building owners to retrofit buildings to be energy efficient. The tradable tax credit mechanism can give rise to positive externalities, above and beyond the positive externality that prompts policymakers to implement a tax incentive, that are created solely because of the tradable mechanism by which the incentive is delivered. The resulting welfare gain distinguishes tradable tax credits from refundable tax credits or direct subsidies. Additionally, the form of the tradable tax credit may help create strong coalitions behind a policy proposal by uniting direct beneficiaries of the social or economic policy with investors and other interested outside parties. The tradable mechanism also provides significant equity benefits, similar to refundable tax credits, and potentially reduces enforcement costs as compared to government interventions that do not make use of third party expertise. Tradable tax credits therefore constitute a viable and potentially useful form of tax incentive in ways not previously recognized.