Why Tax Credits Aren’t Controversial & Why They Should Be

Ah, tax credits. The answer to all of our environmental, social, and urban cares. Or so they say.

This spring, Senator Maria Cantwell (D-WA) and Senator Orrin Hatch (R-UT) cheerfully joined forces to expand the Low Income Housing Tax Credit (LIHTC) program. Their bill was subsequently referred to the Senate Finance Committee, which Hatch chairs. LIHTC provides select developers with tax credits for building affordable housing units, and the newly minted Affordable Housing Credit Improvement Act of 2016 would enlarge the LIHTC program by 50%, which puts the program at about $11 billion annually. If it’s anything like previous expansions of the program, it will surely draw broad bi-partisan support.

This brings us to a rather heartwarming aspect of tax credit programs more generally: tax credits appeal to democrats and republicans alike. In an age of acute political polarization, such collaboration seems to be the essence of civility and fraternization that the American public so longs for. Or is it?

Enter the alternative hypothesis: tax credits get a free pass because people think that tax credits are free. Unfortunately, as Milton Friedman said, TANSTAAFL, or “there ain’t no such thing as a free lunch,” and someone, somewhere paid for that hotdog and chips. So the question is who’s paying for tax credits?

The answer -- if you’re not utilizing the credits -- is probably you. That is because although select businesses or individuals are writing off taxes owed, the total U.S. tax burden is consistent or growing. Unlike across-the-board cuts that reduce taxes for everyone and are designed to support economic growth, LIHTC and other tax credit programs choose special businesses or individuals to reduce taxes for. So in the absence of reductions in spending, you’re just moving the money around, akin to any other direct subsidy (e.g. ethanol). When Uncle Sam needs to collect, the American tax payer is still on the hook.

Of course indirectly, we all “pay” for tax credits due to the slower economic growth caused by the misallocation of capital.

What’s more, tax credits operate outside of the annual Congressional appropriations process, and do not appear as an expenditure on the federal budget. In other words, a tax credit program may be completely ineffective at accomplishing program goals and never warrant so much as a side-eye come budget season.

This is particularly problematic for LIHTC, which National Bureau of Economic Research, Journal of Housing Economics, and Journal of Public Economics studies all found subsidize affordable units by displacing affordable units that would otherwise be provided by the private market. Economist Ed Glaeser agrees: “current research finds that LIHTC is not very effective along any important dimension—other than to benefit developers and their investors.” In other words, rather than improving welfare, LIHTC may actually just improve corporate welfare.

In the case of LIHTC and other tax credit programs, regular budgetary oversight would provide an opportunity to determine whether there is a better use for our collective resources, whether the program is achieving its objectives, and whether the country has the political will to continue supporting the program. Yet tax credit programs are protected from these basic questions by their very design.

And that is why tax credits are a problem. But out of sight on the federal budget outlay, out of mind. In the meantime, Congress will continue to play a cute little bipartisan game until American taxpayers get suspicious about all of that celebrated bipartisan collaboration happening in Washington.