What’s the Point?

In a blog post on Cafe Hayek, Tax cuts for the rich, Russ Roberts makes several good points worth considering if you’re interested in learning more about all sides of the tax policy discussion.

I think this may be the most interesting and powerful point:

I also think that much (most?) of any tax increase is offset by changes in pre-tax wage rates. This last inconvenient truth is usually ignored by people on all sides of the tax debate. It is just presumed that changes in tax rates have corresponding effects on the distribution of income. This is not true.

If you’re not so sure, answer this: 

Do you think home prices would rise, fall or stay the same if the mortgage interest tax deduction was eliminated tomorrow?

If you think home prices will fall, I agree.  Without the mortgage interest tax deduction, folks will want smaller mortgage payments because they would no longer think of their mortgage payment as the net of the payment and the tax savings. Smaller payments mean smaller loan amounts which means they’d have less cash to buy a home and wouldn’t be willing to spend as much.

I think many people can intuitively grasp the plausible link between the mortgage interest tax deduction and home prices.

If it’s true, that means the mortgage interest tax deduction is an illusion.  What we believe we’re saving in taxes, we’re actually paying out with a higher home price.  At least, part of it.

If you believe that the mortgage tax deduction could result in higher home prices, you should also understand Roberts’ observation that higher income tax rates might cause higher pre-tax wage rates.

As I thought about Roberts’ observation, it occurred to me that any tax or tax deduction could influence the pre-tax value of any transaction.

As taxes on cigarettes were increased significantly, who paid?  Smokers paid with higher cigarette prices.  That’s a given.  A lot of people know this and support it because they believe those higher prices paid by smokers help offset the higher medical expenses smokers are expected to generate.  So here’s another example where the tax rate on the transaction directly caused a change in the price of the product being taxed.  It’s also example where that result surprises no one.

Here’s another one. If the U.S. imposes a tariff for on imported cars, who pays?  Car buyers do.  They pay a higher price for all cars as a result of the tariff.  Here again, a higher tax caused a higher car price.  There’s evidence that people on both sides of the issue understand this as well.  A protectionist recommend tariffs for this exact reason, while economists generally do not recommend tariffs for this reason.

So, given all these examples, it surprises me that nobody seems to consider that a tax on income can change the pre-tax income.  If true, then it’s not possible to use a tax code to alter the distribution of purchasing power.

If all this is true, then we allow the tax code to be nothing more than an instrument that elected officials can use to create illusions that to gain themselves political favors from special interests.

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