Tax-Reporting Implications of Asymmetric Treatment: Direct Subsidies vs. Tax Deductions

Abstract

The Treasury Department has criticized use of the federal income tax system to deliver indirect subsidies to taxpayers in the form of tax deductions, and recommended that all such deductions be eliminated. It recognized, however, that it would be necessary to replace some tax deductions with direct subsidies. Using an experiment, we examined whether the form of the subsidy (tax deduction or direct subsidy) affects tax reporting. Despite the economic equivalence of the two forms of subsidy, we found that taxpayers who are disadvantaged by not receiving a direct subsidy reported more income than taxpayers disadvantaged by not receiving a tax deduction.