The Hidden Entitlements
PART II
Tax Expenditures for Business & Investment
Some analysts have claimed that our current income tax is biased against savings. They further argue that this alleged bias has caused a lower national savings rate than we otherwise would have. And thus, they conclude, we need to tilt the tax code so that it rewards saving and punishes consumption.
This is an interesting theory, but it hardly squares with reality. The truth is that the current tax code includes huge tax breaks for savings and investment.The loopholes range from no tax at all on some kinds of investment income,to outright "negative" tax rates on the profits from certain corporate investments, to industry-specific tax breaks targeted to the politically powerful. In fact, the $230 billion annual cost of tax expenditures for savings and investment is now almost equal to the total annual amount of personal savings! The government is borrowing to cover the cost of these tax breaks, yet they have had no discernable effect on the private savings rate. As a result, the loopholes end up as a large drain on overall national savings. Thus, it seems rather apparent that if our savings rate is too low, tax breaks have been part of the problem, rather than the solution.
Savings and investment tax breaks are not simply a failed experiment in macroeconomic engineering. They also cause significant distortions in business decision making--to the detriment of overall economic growth. Worst of all,most savings and investment loopholes seriously undermine tax fairness.In fact, with one major exception--tax breaks for retirement savings--the current tax expenditures for savings and investment are extremely tilted toward the very best-off people in the country.
One of the key goals of the 1986 Tax Reform Act was to curb the harmful economic distortions that the "supply-side," loophole-based policies of the seventies and early eighties had produced. As the official report on the 1986 Act notes, in the mega-loophole era "the output attainable from our capital resources was reduced because too much investment occurred in tax-favored sectors and too little investment occurred in sectors that were more productive but which were tax-disadvantaged."
Although the 1986 reform bill did not eliminate all tax-induced investment distortions, it did make great progress--and our nation's economy has done better as a result. Unfortunately, many in Congress today seem to want to return to the bad old days when a major share of our nation's capital stock was diverted into tax-motivated schemes at the expense of more productive investments. But surely that's not what our economy needs. On the contrary,the right policy for enhancing savings and investment is to reduce the government's long-term budget deficits and to close--rather than expand--remaining economically harmful tax loopholes.
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