Paul L. Caron

Friday, July 25, 2008

Jenn: The Case for Tax Credits

Brian H. Jenn (Skadden, Washington, D.C.) has published The Case for Tax Credits, 61 Tax Law. 549 (2008).  Here is the Conclusion:

Over the last few decades, Congress has increasingly relied on tax credits as an alternative to deductions and exclusions in the implementation of tax expenditures, particularly those meant to create incentives for certain behaviors. The Earned Income Tax Credit is perhaps the most prominent example, but it is far from the only one. In fact, the Code contains a whole constellation of less significant credits aimed at encouraging individuals to engage in a variety of different behaviors, from adopting children to purchasing alternative fuel vehicles. Nonetheless, the largest tax expenditures affecting the greatest number of people continue to take the form of deductions and exclusions from gross income.

This Article has relied on equity and efficiency criteria to analyze whether existing credits and deductions would more effectively implement the government’s goals if they were replaced with comparable credits. In the most general case, credits seem more vertically equitable than deductions and generally exhibit superior technical efficiency properties. With uniform marginal incentives across taxpayers regardless of tax bracket, itemization status, and possibly filing status (if credits are refundable), a credit can give the government its greatest “bang for the buck” of foregone revenue. In contrast, devices that create marginal incentives based on a taxpayer’s marginal tax rate are more likely to be inefficient, over-incentivizing some taxpayers while under-incentivizing others. These efficiency advantages are general enough to justify a presumption in favor of designing tax incentives as credits, a presumption that seems to hold in the case of benefits for health insurance, state and local taxes, and state and local bond interest—all of which could be more equitably and efficiently implemented as credits. Nonetheless, the presumption in favor of credits is by no means insurmountable. In fact, based on the criteria developed in this Article, there is only a mixed case for converting the home mortgage interest deduction and charitable contribution deduction into credits. In light of these conclusions, it is interesting to note that the President’s Advisory Panel on Federal Tax Reform recommended converting only the home mortgage interest deduction to a credit.

The analysis undertaken in this Article may have implications for tax system design beyond the question of whether credits or deductions are the optimal way to implement tax expenditures. One issue that could be further developed within the framework of this Article is whether floors for credits and deductions are appropriate elements of tax incentive design. The logic of neutrality would seem to argue against floors or other thresholds, but such considerations must be weighed against the administrative conveniences a floor offers (for example, eliminating many small claims) and the efficiency gains from a reduced need to “buy out the base.” Another issue briefly touched on here is the distinction between above-the-line and below-the-line deductions. A case might be made to allow all deductions as above-the-line deductions (perhaps with a minimum claim amount for administrative ease) on the grounds of equity and efficiency as those considerations were developed in this Article. Design issues such as these could be a fruitful area for future research.

In light of the growing burden of the Alternative Minimum Tax, large-scale tax reform may be on the not-too-distant horizon. In that context, policymakers should consider whether existing deductions are the most effective way to achieve the policy goals and whether credits present an attractive alternative. It is no small matter that credits could easily be structured to reduce the ultimate revenue cost to the federal government by reducing the value of the credits to the wealthiest taxpayers. Ultimately, however, the decision should be grounded on rigorous case-by-case analysis of equity and efficiency criteria.

ABA Tax Section, Scholarship | Permalink

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