Surgery with hammers

So the House passed a tax bill including a measure that will make Vermont’s income tax system more progressive by capping itemized deductions at 2.5 times the standard deduction. Since affluent taxpayers benefit from deductions far more than low earners, the deduction cap will (modestly) increase their taxes.

That’s a good thing. And of course the Senate can’t leave it alone.

Sen. Tim Ashe, D/P-Chittenden, chair of the Senate Finance Committee, wants to take a more “surgical” approach [to tax deductions].

… In a Senate Finance Committee bill he introduced on Tuesday, Ashe proposes three changes: A cap on mortgage deductions (to be determined, but between $12,000 and $15,000); a 3 percent minimum income tax; the elimination of charitable deductions and the creation of a 5 percent income tax credit for donations of over $5,000 made in Vermont.

Tim Ashe is a very smart man. He should consider developing a personality if he wants to run for higher office, but he’s got a lot of good ideas — such as wanting to take a comprehensive look at how our tax structure works and doesn’t work.

But “surgical” is a misnomer in this case. Using tax deductions and tax credits to influence public behavior is inherently inefficient.  Those tax breaks are almost always marginal and have little to no effect on most financial decision-making by individuals and businesses. This is especially true of state tax policy: Vermont’s deductions are worth far less than the federal ones, and their impact is feebler and harder to measure.

Don’t believe me? Well, when was the last time “tax implications” were a decisive factor in a purchasing decision?

Sure, it’s a factor, but the benefits are dwarfed by the costs. We’d be far better off if we stopped trying to micromanage how people use their money and created a much simpler tax system.

Still don’t believe me? Okay, let’s take a popular and very direct tax incentive: the sales tax holiday. Yes, it encourages people to buy goods on a given day — but most of those goods would have been purchased anyway, sooner rather than later. The tax holiday concentrates that purchasing in a single day, but it creates little or no additional demand. The state foregoes sales tax revenue for very little real effect on the economy.

Still don’t believe me? How about this: even when a tax incentive has an effect, it has even greater side effects. Take, for example, the mortgage interest deduction: it has encouraged home ownership — which may or may not actually be a good thing, especially in an age of greater mobility — but it gives the biggest tax breaks to those who need them least. A rich guy owning a million-dollar home and a country estate will get a whole lot more benefit than a median-income family scratching out a mortgage.

The mortgage interest deduction’s unintended consequence: We are all subsidizing the mansions and playgrounds of the wealthy.

Ashe’s ideas for a “surgical” approach seem okay, I guess, but I’d much rather take the House’s approach of a simple deduction cap. Let’s stop pretending we can steer our economy through the tax code. Let’s have a bias for simplicity when considering changes to our tax code.

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