On the Road to Incoherence: Congress, Economics and Taxes

Abstract

Congress is frequently criticized for social engineering by means of tax provisions. Critics of tax incentives, or tax expenditures, base their objections on equity and economic arguments. This perspective views tax expenditures as an ill-advised deviation from what they view as the tax code's primary purpose of revenue raising. This Article argues that these critics are ignoring the existence of a long economic tradition of using tax penalties and incentives to address externalities that the market fails to price adequately. This economic tradition, which is also called Pigouvian taxation, has generated a significant body of literature demonstrating that taxes can be an optimal solution for correcting externalities where a large number of people are making use of public goods. This is not to say that tax expenditure analysis has no role to play in tax policy, but simply that the economic tradition of Pigouvian taxation also has an important role to play. Unfortunately, when it comes to tax legislation, Congress often ignores both tax expenditure and economic analysis. To illustrate this point, this Article uses as a case study a 1997 tax amendment that expanded the tax benefits accorded to employer-provided transportation. As a result, tax incentives are now generally available that exacerbate urban congestion and air pollution problems. Congress similarly ignored the economics associated with the employment relationship, especially the importance of employment taxes in shaping the behavior of both employers and employees, and as a result it failed to appreciate the likely result of its amendment - that employers would use these expanded tax benefits to reduce their share of employment taxes. What is most troubling about Congress's use of the tax code for social engineering is that Congress is clearly confused about the very nature of how taxes can be used to control externalities and is now using a tax subsidy when it should be using a tax penalty. Because no tax expenditure analysis is required for employment taxes, Congress also was unaware that this provision would result in significant revenue losses for Social Security and Medicare and ignored implications for individuals dependent on Social Security. This Article draws a number of lessons from Congress's use of taxes. Among other reforms, the Article suggests that Congress make intelligent use of Pigouvian taxation by considering first whether an incentive or a penalty is appropriate. Because of the looming importance of employment taxes for our nation's fiscal future, this Article also urges the establishment of a tax expenditure budget for employment taxes similar to that already mandated for provisions affecting income taxes.