Tax reform misses point, hits savings, kids
Would-be tax reformers on Capitol Hill are taking a “blank slate” approach to the issue. Republican U.S. Rep. Dave Camp of Michigan and Democratic Sen. Max Baucus of Montana, who are in charge of the tax-law committees in their respective houses, say that every tax break is on death row unless a strong case can be made for it.
This method rightly recognizes that not all tax breaks are the same: Some of them have better justifications than others. What the blank-slate approach misses, though, is that not all supposed tax breaks are even tax breaks.
The tax-reforming duo of Camp and Baucus count the deferral of taxation on contributions to 401(k) retirement plans as a tax preference, for example, and thus something that is presumed to be a bad idea until proved otherwise. But plenty of economists would argue that this provision of the tax code isn’t a break at all. In their view, we should tax income when it is consumed. Taxing savings instead creates a bias in favor of consumption today over saving for consumption tomorrow, and even more over saving for consumption the day after tomorrow. So the alleged tax preference for 401(k) plans isn’t a “break” in the sense of a departure from the ideal tax base. It’s a partial corrective for a tax code that doesn’t define the base properly to begin with.
Fewer economists would defend the tax credit for children, which reformers also sometimes put on the chopping block. Yet it too should be seen not as a break but as another partial corrective to a bias in federal policy — a bias against the investment we call parenting.
This bias is a side effect of something that most people consider a blessing of modern life: government programs to take care of the elderly. Before such programs, provisions for the elderly usually took the form of a generational bargain within families — parents took care of their children before they grew old enough to work, and they were in turn taken care of when they grew too old to work.
Entitlements — in the U. S., Social Security and Medicare — socialized this bargain but didn’t erase it. We depend on the next generation, collectively, to take care of us in our old age. But we don’t all contribute to the same degree in raising the next generation.
Hence the bias. Making financial sacrifices to raise children is a substantial contribution to the health of entitlement programs. But raising children doesn’t reduce the taxes that parents must pay for the programs or increase the benefits they receive from them. The more kids a taxpaying family raises, the more others are free-riding off its investments.
It isn’t surprising, then, that some social scientists have found that the creation and expansion of programs for the elderly tend to reduce family size. One study looked at the decline in birth rates in the U.S. and in Western Europe after World War II and found that roughly half of it could be explained by the growth of these programs. Generous entitlements and overtaxed parents mean that fewer people have any children and fewer people have more than one child. (It also means that fewer people get married early in life, or at all.)
The tax credit for children offsets a small portion of this bias against parenting. Tax reform shouldn’t scale back the child credit. It should expand it. The economist Robert Stein has suggested that for the government to be neutral with respect to the decision to have children — neither discouraging nor encouraging it — the child credit, now $1,000 a child, would have to be expanded fourfold or more.
The point of the child credit isn’t to get people to have kids they don’t want. It isn’t even primarily to make it easier for them to start families and raise larger families if they want. It’s to reduce the unfair tax burden they face. Even if expanding the credit did nothing to raise the birth rate, it would be the right thing to do. The strong federal bias against having children is something of an accident: We would never have adopted it as an explicit policy. It’s also something we can rectify.
Tax reform should move us in the direction of taxing consumption rather than saving and investment. It’s important to remember, though, that investments don’t just include stocks and bonds and factories. Tax reformers should pay at least as much attention to the most important investments in the future that most people ever make.