The Role of the Tax Provision as a Public Policymaking Tool

Tax credits and tax deductions are two important provisions in the federal government's tax code. A tax deduction is defined as any amount subtracted from gross taxable income before tax liability is calculated. For example, $120,000 of taxable income may become $100,000 of taxable income after itemized deductions are examined and approved. On the other hand, tax credits are designed to directly reduce the amount of taxes due by offsetting net income tax liability. For instance, if one owes $5,000 in federal income tax, but has in the past year purchased a solar water heating system for which the government provides a $2,000 tax credit, total taxes due will instead be offset to $3,000.

Tax credits and tax deductions play a significant role in the operation of the federal government. Tax credits are often utilized as a way of encouraging individuals and businesses to participate in what the government deems "productive" behavior, whether it is purchasing an energy-efficient heating system or adopting a child. Tax deductions are often thought of in conjunction with business expenditures; travel expenses, home expenses, even entertainment expenses for business purposes can be itemized as deductions. Tax deductions are by no means limited only to the business sector: health expenses and the charitable contributions of individuals can be deducted as well. In short, these tax credits and deductions exist as important tools for policymakers to utilize.

As the federal government continues to expand, so does the number of tax credits and tax deductions available. The prevalence of interest groups and lobbyists ensures that the government is petitioned to establish tax credits and deductions targeting many different industries and products, while on the other hand, the rise of "alternative energy" has led to many consumer-based tax incentives as politicians attempt to motivate certain purchasing behaviors.

Concept Linkage

In October of this year, the Wall Street Journal released a controversial editorial describing Presidential candidate Barack Obama's tax plan as an effective program of stealth "welfare." At issue were the numerous tax credits offered under Obama's proposed plan, and of those, the refundable tax credits received particular scrutiny. (Refundable tax credits are those tax credits that can reduce one's tax liability below zero, thus resulting in a government "refund" to the citizen in question. Most, but not all, tax credits are of the non-refundable variety.)

According to the Wall Street Journal's analysis, the refundable nature of Obama's tax credits, in conjunction with already-existing and proposed non-refundable tax credits, means that many workers who do not pay federal income tax (some 40% of the population) will receive a refund check from the government. The Wall Street Journal characterizes their findings as a conscious attempt to redistribute wealth. Issues may be had with the Wall Street Journal's analysis: their starting assumptions about the Obama tax code differs wildly from the non-partisan Tax Policy Center's analysis; they fail to take into account the effect of the federal payroll tax and excise tax on the average citizen; and their disregard of the Obama plan's scalable tax credit structure and its link to work and income throws some of their findings into question.

Nevertheless, this example makes it clear to see how tax deductions and tax credits can easily become the centerpiece of contentious policy debate. Indeed, anything involving money and the government-particularly when tax dollars are involved-is sure to be controversial in certain sectors. Credits and deductions for businesses and individuals are debated at all steps, and their prevalence is looking to grow in the future, as interest group pluralism and a sympathetic Washington establishment looks to utilize these credits and deductions in future policymaking.

Concept Application

In recent years, the rise of behavioral economics in both the academic and public arena has led to a rise in tax credits designed to influence behavior. Richard Thaler, co-author of Nudge: Improving Decisions About Health, Wealth, and Happiness, is one of these economists. As the title suggests, Nudge advocates for the institution of policies that encourage a certain behavior over another, and tax policy (both deductions and credits) is one means of achieving this. Austan Goolsbee, leading economic advisor to Barack Obama, is another behavior economist: his influence can be seen in Obama's $7,000 tax credit (non-refundable) towards purchasing a flex-fuel vehicle, and in Obama's tendency against full mandates in his health care policy (a propensity towards "nudge" instead of "force" that behavior economists often advocate). The policy advocacy of behavioral economists has gained steam in recent years as an alternative to the more traditional (and touchy) economics of the political left and right.

Policy analysts may also examine currently existing tax provisions in an effort to determine their effectiveness. For instance, in a study of the Earned Income Tax Credit-a strongly bipartisan refundable tax credit, instituted by Gerald Ford in 1975-Katherin Ross Phillips finds strong evidence for the tax credit's effectiveness, having pulled more children out of poverty "than any other means-tested or social insurance program" (Phillips 2001, 414) since it was instituted. The Earned Income Tax Credit is considered so successful, and is surrounded by such little controversy, that it has consistently been expanded under both Republican and Democratic administrations, with the largest expansions being under the watch of President Reagan, President George H.W. Bush, and President Clinton (Phillips 2001, 415). The EITC occupies an unusually strong position of support within both parties, and its continued operation is a hallmark achievement of the tax credit.

In short, there is very little debate over whether the tax provision can be an effective tool in the public policymaking process. The bipartisan support for the EITC speaks well of the tax credit's success and for the strong political viability that similar tax provisions can often earn.

Concept Evaluation and Conclusions

Tax credits and tax deductions are incredibly important to the field of public policy and public policy analysis for just these reasons. They represent a genuine "third way" in politics that can often muster bipartisan support, and they appear to be playing an ever-growing role in the operation of our federal government.

As such, public policy analysts have much to gain through the study of existing tax credits and deductions. Just how effective have these provisions proven to be? Where are their approaches lacking, and in what ways can they be improved upon? What does their success say about other approaches to policymaking, including arguments between increased government spending and increased tax cuts? The incoming Obama administration has proposed the creation of numerous tax credits, and through the careful study of existing tax credits, policy analysts are in a position where their findings could directly influence just what role these credits play in the future.

Of course, there are always limits to these analyses. Our current system of tax credits and deductions is incredibly complex, and it may be hard to isolate the effects of one tax provision from the effects of another provision or government program. It is only possible to determine a certain level of causation in the area of public policy and economics, and for that reason, continued study of these tax policies will carry significant importance.

In the end, it is clear that tax credits and deductions hold a strong position going forward. Their success has been heralded in the past, and with an incoming administration promising the creation of an ever-growing number of targeted tax provisions, it is unlikely we will see this trend end any time soon.