Since many people continue to unwittingly promote socialism with their misguided insistence that "every tax cut is good," I'm going to illustrate why a TARGETED (e.g., just for one entity) tax break is welfare, economically equivalent to a subsidy, and a cost to other taxpayers.
Imagine a state with only three people: Al, Bo, and Cy. Each person pays \$4 in annual taxes, so the government collects \$12 total. The government spends all that money providing services. It distributes services equally among its residents and is required to balance its budget.
Suppose the government wants to attract a new person, Di, to the state. The government is excited about all the business Di will bring, so it promises Di that her annual taxes will be only \$1 if she makes the move. Di is thrilled and accepts the offer.
Now the state has four people. The government collects \$13 in taxes (\$4 + \$4 + \$4 + \$1) to be spent on services. But because government services are distributed equally, Al, Bo, and Cy now receive only \$3.25 each in services (\$13 / 4), even though each still pays \$4 in taxes.
In other words, Al, Bo, and Cy now get less for each tax dollar; their effective tax rate has gone up, thanks to the government's special break for Di.
Suppose the government attempts to maintain government services at the level provided prior to Di's arrival, i.e., \$4 per person in services. Since the state now has four people, the government will need to collect \$16 in taxes. It currently collects \$13.
Di's annual taxes are fixed at \$1, so the additional \$3 will have to come from Al, Bo, and Cy. Consequently, Al, Bo, and Cy will have to pay \$5 per person in taxes, to receive \$4 per person in services, thanks to the government's special break for Di.
Even if the government convinces Di to bear some of the additional tax burden, or finds another way to raise revenue, if any portion of the \$3 comes from Al, Bo, and Cy, they will pay more in taxes than they receive in services, thanks to the government's special break for Di.
Meanwhile, Di is living large. She is paying only \$1 in annual taxes while receiving \$3.25 to \$4 in government services. The difference is a welfare subsidy to her, no less than if the government forced Al, Bo, and Cy to write her a check or hand her some cash.
The fact that Di is receiving services paid for by others rather than dollar bills from others does not make the transfer any less a welfare subsidy.
What about the claim that Di's arrival will boost the economy and more than pay for her special tax break? Many of the proponents of this view seem unaware that they are advocating central planning, a main tenet of socialism. To see this, let's return to the illustration.
Advocates of Di's special tax break are saying that, ALL ELSE EQUAL, they would rather give Di a very large tax break (75%) than give everyone a modest tax break. In other words, they believe that government central planners can outperform the market by shifting money to Di.
If your reply is "give others a tax break, too," then you've missed the point. You can't give others a tax break AND hold all else equal. The budget must be balanced; government spending would have to be cut. The relevant analysis is how best to tax at a GIVEN level of spending.
We could rerun this illustration at a much lower level of government spending, and the relevant analysis again would be how best to tax at this level of spending: Is it best to give one person a very large tax break or to give everyone a modest tax break?
For a primer on why the free market is superior to central planning, read this: fee.org/articles/the-u…. In short, keeping more money in the hands of everyone produces better economic outcomes than giving a special advantage to one person.
When advocates of Di's special tax break talk about the economic growth and jobs it will create, they commit the broken window fallacy: fee.org/articles/the-b…. They ignore the break's opportunity cost; the government has deprived Al, Bo, and Cy of a tax break. That's a net loss.
We can imagine variations of this illustration. For example, maybe Al, Bo, Cy, and Di already live in the same state, and then the government gives Di a special tax break for "economic development." The end result, however, is the same: The special break is economically harmful.
This illustration is not meant to suggest that humans can design a perfect tax code. But when the government intentionally gives a special tax break to one entity, not only is the government undermining the Rule of Law, but it also is knowingly harming the economy.
Bottom line: Targeted tax breaks are bad.
Happy birthday, Frédéric Bastiat!
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