On the Legitimacy of Tax Loopholes

by Don Boudreaux on April 8, 2012

in Budget Issues, Other People's Money, Politics, Seen and Unseen, Taxes

Here’s a letter to the New York Times Magazine:

Adam Davidson, Jacob Goldstein, Caitlin Kenney, and Dad Kedmey write that tax loopholes “will cost the government roughly $1 trillion in lost revenue this year” (“What’s the Easiest Way to Cheat on Your Taxes?” April 8).  Although such claims about the tax-loss “costs” of “loopholes” are common, they’re also questionable.

If, as most people assume, government has a legitimate claim on a portion of peoples’ incomes, government must also be assumed to make its decisions non-arbitrarily and in ways that further the public interest.  (If either or both of these assumptions don’t hold, it’s difficult to understand why anyone would lament – rather than celebrate – any revenues that the government “loses” to loopholes.)

So if we stick with the assumption that government acts non-arbitrarily and in the public interest, then tax “loopholes” are as legitimate a part of the fiscal bargain between voters, taxpayers, interest groups, and politicians as are determinations of the tax base and tax rates themselves.  Marginal tax rates on corporate incomes, for example, might be lower but for a fiscal bargain in which higher rates won majority approval in Congress only because certain corporate deductions were approved in exchange.

I don’t here suggest that today’s tax policy is optimal.  I do, however, insist that it’s illegitimate to suppose that each feature of the tax code is designed and implemented independently of other features of fiscal policy.  And, therefore, it’s also illegitimate to assume that tax deductions prevent government from receiving revenues that it ‘should’ – or even that it ‘intended to’ – receive.

Sincerely,
Donald J. Boudreaux
Professor of Economics
George Mason University
Fairfax, VA  22030

Put somewhat differently: On the theory of fiscal exchange implicit in most democratic-government-is-legitimate accounts of the state and its operations, it makes no more sense to label a tax “loophole” as being a source of “loss” to the the government than it would to label, say, a landlord’s decision to give new tenants their first two months of rent “free” as being a source of “loss” to the landlord.  Presumably, the landlord made this offer to his or her new tenants in order to increase business over time in profit-maximizing ways.  If the landlord is correct in this assessment, his or her failure to have made this offer would have resulted in a smaller stream of profits over time.

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