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Tax Credits vs. Spending: Why Progressives Should Care How the Stimulus is Delivered

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As Obama gets to work brokering a deal for his stimulus package, bipartisan agreement actually seems possible. This optimism stems from Obama's recent indication that his proposal will include a greater reliance on the tax system as a means of delivering needed aid.

Described as a move to placate wary Republicans who shudder at an ungodly price tag nearing $800 billion, Obama has indicated that nearly half of the package will take the form of tax credits to individuals and businesses. As a political strategy, this tax-cut-heavy proposal seems smart, as evidenced by Republican leader Mitch McConnell's assessment of the proposal as "the sort of thing we could have bipartisan agreement on."

But, from a progressive perspective, does the use of tax credit represent a political compromise that will limit the potential for the stimulus to seed more substantial policy change? Or is this truly a policy design that everyone should embrace? To answer these questions, I identify the key differences between tax credit and direct spending policy designs. These differences illustrate what is gained and what is lost by taking a tax-focused approach, as well as the details that progressives should attend to in order to make full use of this political opportunity.

Before highlighting differences, I should note that tax credits operate like spending programs in many ways. Most importantly, they must be paid for through higher taxes elsewhere or equivalent cuts in spending to make up for forgone tax revenue. For this reason, I prefer the term "tax expenditures," which better captures the (albeit indirect) spending resulting from policy. Of course we know that, despite their budgetary similarity to direct spending programs, tax expenditures remain more political popular, easier to enact, and more sustainable over time. This is the result of a set of key differences, described below.

#1: Tax Expenditures have Hidden Costs

As described by Christopher Howard in his book, The Hidden Welfare State, the forgone taxes from tax expenditures do not show up in the normal government budgeting and policy review process. As a result, tax expenditures can provide governmental benefits without increasing the measure of government spending and by (ironically) seeming to reduce the total size of government. Not surprisingly, this slight of hand is popular with policymakers from both political parties who enjoy distributing benefits with little attention to their costs, making them much easier to enact and protecting the benefits from later cuts.

#2: Tax Expenditures have Hidden Beneficiaries

Since tax expenditures are distributed through the tax system, citizens can claim a benefit without needing to apply for or enroll in a government program. As a result, these benefits typically come with little stigma of the sort attached to Food Stamp or unemployment insurance receipt. This feature explains the paradox of wealthy conservatives who express disdain for those accepting welfare while happily claiming their mortgage and employer health insurance tax deductions each year. And it also helps explain why calls to cut government largess rarely focus on eliminating benefits delivered through the tax system and focus instead on cuts to programs that can be more easily attacked as handouts for the undeserving.

#3: Tax Expenditures Bypass the Appropriations Process

Unlike spending programs which must be first authorized and then go through appropriations to receive actual funding, tax expenditures are created and funded by the same committee in each chamber of Congress. This cuts in half the number of veto points (times that an organized opposition can kill a proposed bill) and makes tax expenditures easier to pass. Further, the absence of an annual appropriations requirement produces a virtual entitlement program in which all eligible tax filers who claim the credit receive the benefit without the waiting lists or capped spending seen in most spending programs. And finally, by avoiding the appropriations stage, tax expenditure proposals pass through the Congressional process avoiding most of the earmarking that produces the "legislative pork" abhorred by most Americans. Since tax expenditures are typically legislated by formula rather than earmark, they remain "cleaner" with less waste.

#4: Tax Expenditures are Automatic Policy Tools

As defined by Lester Salamon in his tome, The Tools of Government, automatic policy tools use an existing administrative structure rather than requiring a new administrative agency or infrastructure. As a result, a new tax expenditure policy can more quickly reach their designated target -- in this case the American economy. In fact, Obama's advisors have expressed a desire to get the stimulus into Americans' pockets quickly and noted a potential strategy in which they will make the individual-level credit retroactive to the 2008 tax year and adjust withholding formulas so that our paychecks will start reflecting the decrease in payroll taxes right away. That quick turnout-around is not possible for a new spending program that requires a more complex implementation structure.

#5: Tax Expenditures are Indirect Policy Tools

Again as defined by Salamon, indirect policy tools are characterized by the separation between the entity authorizing and financing the tax expenditure (in this case the federal government) and the entity that will actually carry out the services the expenditures provide. As a result, government has little control over how, when, and where government funds are spent. This is seen as an advantage by those wary of government intervention and trusting of the market, but as a disadvantage by those wanting to target the stimulus package to particular ends (such as spending rather than saving or to food assistance versus more fungible aid). In the longer term, reliance on indirect policy tools can also decrease public support for governmental solutions to social problems. This effect is illustrated in Jacob Hacker's The Divided Welfare State, which illustrates how our nation's heavy reliance on private pension and health benefits creates incentives for private actors to block significant public expansions in these areas. He notes how indirect support in the form of tax expenditures (and subsidies) from the government to private businesses and actors can facilitate the organization and advocacy of these groups who stand in the way of later public service expansion.

Implications for the Stimulus and Beyond

Considering these features, it is likely that Obama's use of tax expenditures for nearly half of the stimulus package is likely to ease enactment of the program by making bipartisan agreement easier due to the hidden costs (#1), the potential for quick and efficient implementation due to the automatic nature of program (#4), the lack of government administration (#5), and the ability to enact a tax expenditure package without opening up the door to earmarks and pork that would raise the overall price tag (#3). In essence, this is as "small" as "big government" can be. As a result, the part of the stimulus delivered this way is likely to be less controversial and more efficiently administered.

Yet, these key differences between tax expenditures and spending programs highlight two other factors of importance to those concerned about progressive policy priorities.

First, the use of tax expenditures makes the distributional consequences of the policy (i.e. who gets what) all the more important since the hidden nature of the costs (#1) and beneficiaries (#2), as well as lack of annual appropriation requirements (#3) will likely allow for any benefits to be sustained over time unlike many welfare, health, and social service programs that are being cut as we speak. This creates a real possibility for policy benefiting low-income and middle-class Americans; but, the degree to which the opportunity is seized depends on the details of the tax expenditures package (rather than the use of tax expenditures themselves).

And secondly, the pairing of tax expenditures with spending programs can overcome most progressive concerns of the tax expenditure approach -- as long as the spending is really done right! For example, although the indirect nature of a tax-focused approach (#5) will dilute the governmental investment throughout our (still) large economy, the other half of the stimulus package comprised of direct spending programs can focus on those areas of aid and investment that we do not want the market alone to determine. For example, investments in already established spending programs that provide unemployment insurance, food stamps, and health care to those in financial crisis can assure that basic needs are met in ways that the more indirect nature of the tax expenditures just can not.

Similarly, since even successful tax expenditures are rarely perceived as governmental assistance, it is the spending programs in the stimulus that will determine public perceptions regarding the capability of government to address a crisis and put us back on the right track. The bureaucratic bungling of a billion dollar package could damn our hopes of large-scale reform for decades, while a careful and competent set of spending priorities enacted without waste and corruption could help rebuild support for public programs that will pay dividends later on. The use of tax expenditures to distribute nearly half of the aid, can actually make it easier for the federal government to spend enough money to stimulate our economy while also cutting in half the size of spending programs that must be carefully administered devoid of waste, fraud, and abuse that would limit later efforts to build on the initial investment.

Elizabeth Rigby, Ph.D. is an Assistant Professor of Political Science at the University of Houston and a Research Affiliate at the National Center for Children and Families at Columbia University. Her work examines the politics of poverty and inequality across a range of child and family programs, including Food Stamps, early childhood education, and Medicaid/SCHIP. She can be reached through her website: www.polsci.uh.edu/faculty/erigby