Scott Sumner  

A tax by any other name . . .

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When the Supreme Court narrowly upheld the health insurance mandate part of Obamacare, John Roberts suggested that the penalty for not buying health insurance could be viewed as a tax.

I'm not qualified to offer an opinion as to whether that decision was correct from a legal perspective, but economists don't see much difference between regulations and taxes. A fine for speeding, or for double parking your car, looks pretty similar to a $4/pack tax on cigarettes, which might be viewed as a "fine" for smoking.

Suppose the Supreme Court had said that a health insurance mandate was unconstitutional. The government could achieve the same effect with a combination of taxes and subsidies. If the penalty for not buying health insurance had been $2500 per household, then the government could impose a lump sum tax of $2500 on all households in America. Then they could offer a $2500 subsidy to all households that purchased health insurance. For those with health insurance, the tax and subsidy would exactly offset--the government could inform those households to not even bother paying the tax and collecting the subsidy. Those without health insurance would be paying a $2500 tax to the government--exactly equivalent to the health insurance penalty under the mandate.

Today, many states are contemplating using a similar subterfuge to undo one of the most important parts of the recent tax bill, the $10,000 limit on the deductibility of state and local taxes. One idea is to have higher income people donate $X to various state health and education programs, and then receive an equivalent tax credit. The donation would effectively serve as a tax payment, and yet it could be deducted from federal income taxes (unlike with SALT payments). And these "donations" wouldn't really be charity in any meaningful sense. People donating the money are no worse off than if they did not donate the money. The alternative was paying the same amount in taxes.

Because legal definitions often don't coincide with economic definitions, there is plenty of room for gaming the system. If states find a way around the $10,000 cap in SALT deductions, it would be a major setback for tax reform, and also further balloon an already excessive budget deficit. This is an issue to watch.

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COMMENTS (28 to date)
Garrett writes:

I think this a good example to point to against the idea that bad laws/regulations should be remedied with offsetting ones, as opposed to repealing the bad ones.

Michael Crouch writes:

Would states require these "donations"? Are donations not, legally speaking, voluntary?

James Pass writes:

I hate to sound like a broken record, but can anyone recommend a good book on libertarian solutions to health care?

Yes, this is an issue to watch. Watching health care issues is like watching a slow-moving train wreck. Health care in the US is convoluted, to put it mildly, and messed up to put it bluntly. I'd like to learn about good alternatives.

Hazel Meade writes:

If the state gives one a tax credit in exchange for a "donation", why doesn't the tax credit count as income?
(Alternatively, it's not much of a "donation" if it's paid for).

Nicholas Weininger writes:

@James Pass: I learned a lot from David Goldhill's "Catastrophic Care" and Arnold Kling's "Crisis of Abundance". Goldhill isn't actually that libertarian but he's valuable anyway as an example of a domain expert who has gone a long way in the libertarian direction by following the evidence.

@Scott: More generally than the legal/economic distinction, I would say the key distinction is between the economics and the political economy. In particular, a tax or subsidy that is not on the government's books, and so does not change either the nominal deficit or the obvious and direct financial burden of government, is typically an easier sell than an explicit tax or subsidy. It's even easier if it can be framed as "making $OUTGROUP stop its supposed mistreatment of $INGROUP," where for example you might take $OUTGROUP = "greedy insurance companies" and $INGROUP = "patients with expensive preexisting conditions".

So regulatory mandates that impose indirect (and often perverse and inefficient) cross-subsidies and tax burdens are likely to get more common as large changes to on-the-books government spending and tax revenue get more difficult. As Arnold says, have a nice day.

BC writes:

From the linked article, Cuomo also proposes changing NY's state income tax to an employer payroll tax, which would be federally deductible. Is that even equivalent, given that employers' federal tax rates are not the same as their employees' tax rates? Apart from that, although one might expect in the long run that employees' pre-tax wages would fall (or not rise as fast as they would have) to offset the effect of shifting the tax from the employee to the employer, in the short run might we expect nominal wages to be sticky? In that case, the proposal could lead to unemployment in the short run.

I'm not sure that it's that easy to enact "economically equivalent" policies, given changing legislatures, rules/procedures, etc. Had the Court ruled the individual mandate unconstitutional, an economically equivalent system of subsidies and taxes would have had to pass a different Congress and might have encountered different treatment regarding filibuster, reconciliation, etc.


"Economists don't see much difference between regulations and taxes".

Levying a tax on an activity does not declare that activity to be illegal. Committing criminal acts (or even civil offenses) can have other repercussions beyond the immediate fines. For example, if one receives too many speeding tickets, then one could lose one's license. A criminal record can damage one's reputation.

I think this distinction came up once regarding Mitt Romney's boat. His boat didn't comply with some rule and, rather than bring his boat into compliance, Romney just decided to pay a fine, basically treating the fine like a tax or fee. That didn't go over well politically when the story came up during Romney's presidential campaign.

Trent McBride writes:

Progressive commentators who are cheerleading for this stuff really need to be called to the carpet on this one. This would be nothing but a tax decrease for the wealthy (in blue states). They are trying to play this off as some sort of progressive maneuver based on where they believe the money would go. Well, 37% of it would go to wealthy (or at least, high income) people, so can't be all that progressive.

I feel fairly confident that the IRS could regulate around this. If I go to a $1000 per plate charitable dinner, and they give me $1000 worth of gifts, I am not supposed to deduct this. Or, they could just rule that state governments are not qualified charities.

As an aside, here in AZ we have a dollar for dollar tax credit for donations to a specified list of charities. So you are trading one tax deductible expense (state tax) for another (charitable donation). Except...if you are subject to AMT, your state taxes are not deductible at the margin, while charity is. So essentially, I got paid by the federal government to make a donation for which the state government was already reimbursing me for. Madness.

Please, somebody come up with a workable politically viable consumption tax, like real soon.

Thaomas writes:

Since I have still not been able to understand what consumption/investment decision was being inefficiently distorted by the SALT deduction, I rather how the subterfuge works.

Scott Sumner writes:

Michael, I don't think they'd be required in a legal sense, but you'd save a lot of money by making tax deductible donations rather than non-deductible state and local tax payments. So presumably most people would go that route.

MikeP writes:

Since I have still not been able to understand what consumption/investment decision was being inefficiently distorted by the SALT deduction...

The SALT deduction motivates states to tax more than is efficient because that consumption/investment is subsidized by taxpayers in other states.

JJY writes:

From the economy side,i think you are right about the health insurance. This is kinds of tax. I think you give a very appropriate suppose about tax and subsidy. The tax purpose is to increase the government income and raise revenue for government expenditures. If the government force people to buy insurance and give subsidy to these people already buy the insurance. This will help the both people and government get their maximum profit.

Thaomas writes:

@ Trent

Politically workable? Who knows? But an "income" tax as we have now* with deductions for "non-consumption"** and higher rates in upper ranges to make the change revenue positive (we should be shooting for structurally zero deficit) ought to work administratively

* but a) no taxes on business income, b) all profits imputed to owners and c) capital gains adjusted for inflation.

** opinions will differ on what is and is administratively feasible to recognize, as non consumption.

Alan Goldhammer writes:

Scott writes:

"Today, many states are contemplating using a similar subterfuge to undo one of the most important parts of the recent tax bill, the $10,000 limit on the deductibility of state and local taxes."

Isn't this just increasing double taxation in the same way that dividend income is doubly taxed (corporations don't get to deduct it and recipients don't either)? I wonder if Scott is in favor of this latter double taxation which has been around for a long time. If some states elect to provide much better services for their citizens through taxation why should this action be penalized through the tax code?

Dave Smith writes:

The SALT is bad policy because it makes average/marginal rates higher than they otherwise would need to be given the amount of revenue generated.

Scott Sumner writes:

Alan, No, the phrase "double taxation" is used in both cases, but the meaning is very different.

With taxes on capital, future consumption is taxed at a higher rate than current consumption. That's why it's bad.

The SALT deduction subsidizes state and local spending, which biases us toward too much spending. It reflects the fact that taxes are levied at two different levels of government.

James Pass writes:

Nicholas Weininger, I really appreciate your book recommendations!

Alan Goldhammer writes:

Scott writes in response to me,

The SALT deduction subsidizes state and local spending, which biases us toward too much spending. It reflects the fact that taxes are levied at two different levels of government.

I strongly disagree with this. I live in a high tax state that has lots of parkland, libraries that are open every day of the week, roads that are maintained like clockwork, a county paid for symphony hall five minutes from my house, etc. These are all things that we taxpayers overwhelmingly pay for and our county council member keep getting reelected by increasing margins. We now have term limits for council members which may or may not be a bad thing.

If citizens are willing to be taxed for spending that they approve of, how can this be wrong? If someone doesn't want to live in an area like this one, they are free to move. Now all we have to do is get Mr. Bezos to pick our area for Amaxon2.

robc writes:

Alan,

There are plenty of things people are willing to buy if they get a 35% off coupon that they wont pay full price for.

The SALT deduction limit is ending the coupon.

MikeP writes:

If citizens are willing to be taxed for spending that they approve of, how can this be wrong?

The citizens in the other states who have to subsidize these citizens by paying their federal taxes for them may find it wrong.

If someone doesn't want to live in an area like this one, they are free to move.

So they can go from receiving the subsidy to paying it? How nice.

Alan Goldhammer writes:

@MikeP - please explain to me how someone in Mississippi subsidizes Montgomery County MD (where I live) while they already receive more money back from the Federal government than they remit in taxes. There are other low tax southern states that also are in this category. Please explain to me why I had to subsidize all the repair work to the New Orleans levee system (to the tune of over $10B) when the citizens of Louisiana probably should have had to pay much more for this than they actually did.

Don't get me wrong. I'm totally against all tax preferences and would have preferred true tax reform rather than what we ended up with. We haven't even touched on local give aways such as tax rebates that also end up shafting the average citizen and force states to come begging at the Federal trough. Wait until earmarks come back.

Scott Sumner writes:

Alan, Your argument would make sense except for the fact that taxpayers in the other 49 states are helping to pay for all of those lovely services.

As a result, many state and local governments engage in lots of wasteful spending, especially on K-12 education.

James Pass writes:

It would help the discussion if we knew what percentage the residents of Alan's county was paying for "all of those lovely services." Alan thinks that the residents "overwhelmingly" pay for them.

In the context of elections, I've heard debates over what constitutes an "overwhelming majority" and a "vast majority." Some people say an overwhelming majority is about 70% while a vast majority is about 85%. Opinions vary and there is no consensus. And we've all heard politicians claim a "mandate" even when they win by a five point margin.

The question seems to be: Even if the residents of Alan's county pay 85% of the cost for all of those lovely services, is this fair? There are many things to consider. For example, what if Alan's county provides lots of jobs, services and recreation to people outside of Alan's county? How should that factor? Or, what should we do with cities and counties that have been hollowed out by sudden and massive loss of jobs?

MikeP writes:

please explain to me how someone in Mississippi subsidizes Montgomery County MD (where I live) while they already receive more money back from the Federal government than they remit in taxes.

The people in Mississippi who subsidize Montgomery County are the doctors, lawyers, engineers, entrepreneurs, etc., of Mississippi who pay most of the federal taxes from Mississippi. For the most part, the recipients of federal outlay in Mississippi don't pay taxes at all and hence aren't subsidizing Montgomery County's civic improvements.

But anyone who believes in progressive taxation should celebrate the end of SALT deductions. Relative to the people you cite in Mississippi, Montgomery County is rich. Higher end taxpayers from Montgomery County paying more taxes should be expected given the current politics of redistribution.

Alec Fahrin writes:

Blue states already subsidize Red states.

What happened to the conservatives who were against more taxes? Aren’t we all Americans? Or do Blue states deserve to pay for the Red states’ tax cuts?

I am all for sneaky get-arounds. This tax cut was a politically motivated partisan dagger into the heart of what little bipartisanship remained in this socially third world country.

Mark writes:

Alan,

Imagine your state decided to go fully communist and impost a 100% tax rate. They'd get to use all the money they collect to provide whatever services they wanted, while still getting to enjoy the provision of federal services (such as military protection, etc.) for free, paid for by other states.

Whether one's state pays more than it gets doesn't change that, in general, how much a state gets back is not conditional on how much state tax revenue they bring in; so it's not as if a state that raises a lot of state-level taxes (and therefore provides lots of services), and concomitantly pays less in federal taxes due to a higher fraction of its citizens' incomes being deducted, gets less in federal services to compensate for the fact that the state is providing more public services.


Alec Fahrin,

First of all, the main reason blue states pay higher taxes than red states is because blue states's policies (regulations, state taxes, etc.) drive up cost of living, which drives up nominal income (and therefore income tax). It's not red states' fault that California and New York have such high costs of living. (cost-of-living-adjusted average state income does not correlate with political affiliation)

Second of all, some blue states do in fact have higher concentrations of rich people, which obviously tilts redistribution away from them toward red states with a higher concentration of poor people. However, this is not due to superior policy but (again) largely due to high costs of living and regulatory barriers (like high minimum wages) making it near impossible for poor people to live in large swaths of blue states (like the entire state of California); hence why there is massive net domestic migration out of (nominally) rich blue state into red states, where it's easier to afford to live and find low-skill jobs. So a think of some of that blue-to-red state subsidy as red states helping to provide services to blue-state refugees who fled the blue states that priced them out of housing and labor markets.

If capping the SALT deduction induces high tax, high cost of living blue state politicians to act rationally (which may not be a given) and reduce state taxes and roll back cost-of-living boosting regulations, this 'partisan dagger' will prove to be a boon for high tax blue state residents.

Or, if you'l like to keep those regulations and taxes in your state, conversely, you and other progressives could always start supporting more federalism, dismantling more of the federal government and shifting taxation and public services onto the state level, allowing each state to choose and fund its own policies and leaving less to the discretion of the federal government. Just a thought.

MikeP writes:

Individuals in Blue states already subsidize individuals in Red states. Amazingly, lots of the former individuals voted for politicians and platforms that made that the case. Maybe they should be more thoughtful about what policies they support.

What happened to the conservatives who were against more taxes? Aren’t we all Americans?

I can't speak for conservatives, but as Americans we should not worry about the amount of taxes as much as the efficiency of taxes. And taxes are most efficient when rates are lowest. To maintain the lowest rates while collecting the same total tax, deductions must be minimized. Deductions are the enemy of efficient taxation, both for pure price theory reasons as well as for rent seeking reasons.

Alan Goldhammer writes:

Scott writes,

Alan, Your argument would make sense except for the fact that taxpayers in the other 49 states are helping to pay for all of those lovely services.

As a result, many state and local governments engage in lots of wasteful spending, especially on K-12 education. I doubt that it is all 49 states since there are a number that have higher SALT than MD. Second, your argument against wasteful spending on K-12 education is curious. In our county we have virtually no movement at all for charter schools and the number of private schools is quite limited; mostly parochial schools. With the disclaimer that both of our children went through the county public school system, I've monitored spending over the years to see what is "wasteful." the majority of the school budget is covers salaries and benefits for the teachers. Administrative overhead always seemed to be reasonable to me. Perhaps in other areas of this country one can make the argument about wasteful spending but this also has to be coupled with a hard look at states where public education is way underfunded (best case study here is Oklahoma where some school districts cannot stay open for a five day week.

MikeP writes,

"The people in Mississippi who subsidize Montgomery County are the doctors, lawyers, engineers, entrepreneurs, etc., of Mississippi who pay most of the federal taxes from Mississippi. For the most part, the recipients of federal outlay in Mississippi don't pay taxes at all and hence aren't subsidizing Montgomery County's civic improvements.

But anyone who believes in progressive taxation should celebrate the end of SALT deductions. Relative to the people you cite in Mississippi, Montgomery County is rich. Higher end taxpayers from Montgomery County paying more taxes should be expected given the current politics of redistribution."The per capita number of high earners that you mention is quite small relative to the population of Mississippi. You might better answer the question, why isn't there a huge migration to Mississippi and job creation compared to Montgomery County MD? Our county has a large base of high salary and/or high technology jobs. Of course some of this is a result of government spending (National Institutes of Health, National Bureau of Standards, Walter Reed Hospital) along with many private sector companies. these are not present in Mississippi.

While I originally took Mississippi as an example, it is not the only state that one might look to. Technology clustering is an interesting phenomena and it seems to be restricted to only a portion of the 50 states.

I'll conclude by noting that in the absence of a constitutional convention to eliminate our current federal/state model (which one might argue is hugely inefficient) that we will have to continue to deal with the disparities that arise. I'll reiterate what I previously said, do away with all the tax preferences including SALT deductions and that will please me.

MikeP writes:

You might better answer the question, why isn't there a huge migration to Mississippi and job creation compared to Montgomery County MD?

Because the states hosting the most productive enterprises haven't yet raised their tax and regulation loads to the point that it takes all the resident surplus of living there.

I live in Santa Clara County CA. The SALT taxes are insane and fund massive churn and waste. But the setting and climate, and the institutional capital that has made a home here because of the setting and climate, provide a greater surplus than the taxes and regulations take away.

On the margin, of course, people leave. Usually they're the people who can't afford the cost of living in a locality that makes it illegal to build new housing. But they are replaced by people who can afford it, and the tax rates can keep on rising.

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