Beware of Governments Bearing Tax Breaks
Donald Trump’s Carrier deal has once again placed the issue of tax breaks front and center in economic policy debates. Free-market economists have been unanimous in their criticism of the deal, but some commentators argue it can be defended as a kind of selective tax relief. For example, Tho Bishop suggests that, if the policy involves tax relief and nothing more, it should be welcomed.
In support of his argument, Bishop is kind enough to quote me arguing in defense of tax exemptions. I agree that, other things equal, tax relief should be provided wherever possible. However, I’m skeptical that anything positive will result from Trump’s new policy. In fact, I think it’s more likely that it will have notably negative consequences; that is, I don’t think other things are equal in this case, as any positive gains will be more than outweighed by negative ones. Put another way, the most appropriate reply to the above proposition about the Carrier deal is a laconic one.
Mises on Tax Exemptions
To understand why, we should turn to Mises. Mises coined the phrase, “capitalism breathes through the loopholes,” a saying often invoked to support various kinds of tax relief (I’ve used it myself here). His words reflect an undeniable truth: entrepreneurs cannot succeed in improving human welfare if they must bear the burden of an increasingly bloated regulatory state.
Enterprise is especially difficult when government introduces “confiscatory” levels of taxation. Here, revenues exceed the amounts required for maintaining vital social institutions, and entrepreneurs suffer as a result. Under confiscatory regimes, taxation seriously threatens the market economy. This is where the benefits of “loopholes” come in. For Mises, the term “loophole” is actually a misnomer, because it refers to perfectly legal actions by entrepreneurs in the usual course of business:
What is a loophole? If the law does not punish a definite action or does not tax a definite thing, this is not a loophole. It is simply the law… The income-tax exemptions in our income tax are not loopholes. The gentleman who complained about loopholes in our income tax… implicitly starts from the assumption that all income over fifteen or twenty thousand dollars ought to be confiscated and calls therefore a loophole the fact that his ideal is not yet attained. Let us be grateful for the fact that there are still such things as those the honorable gentleman calls loopholes. Thanks to these loopholes this country is still a free country… (1951, pp. 115-116)
It’s reasonable to conclude that reducing taxes and regulations is vital for promoting a peaceful and prosperous society, even if these benefits cannot be extended to all entrepreneurs at once.
However, Mises’s views on taxation are not as straightforward as we might think based on his praise of loopholes. In fact, he was critical of tax exemptions in certain cases where he considered them to be government-granted privileges that distorted the market. For him, targeted tax breaks for companies or industries could be examples of interventionism run amok.
He discusses this issue mostly clearly in an overlooked essay titled, “Observations on the Cooperative Movement.” In this report, Mises argued that the cooperatives of his day were taking advantage of unfair benefits from targeted tax exemptions that were not also granted to ordinary businesses. I won’t comment here on whether his assessment of the cooperative movement is accurate; instead, I’ll focus on his ideas about taxation.
Importantly, Mises’s arguments are partly based on the idea that there is an efficient level of taxation necessary for the maintenance of public order, and that it is the duty of all citizens to pay their fair share of this amount (1990, pp. 247, 268). If some firms try to shirk their civic duties, this requires that the burden of taxation be increased for the remaining producers. In general, “For the sake of consumers’ sovereignty and for the benefit of the whole people, there should be equality in the treatment of all kinds and varieties of business enterprise” (1990, p. 252). It’s with this in mind that Mises considered some tax exemptions to be unfair privileges for producers.
In particular, Mises believed that in an economy with a “suitable” level of taxation, organizations lobbying for tax exemptions will tend to be inefficient producers trying to protect their failing businesses (this, for example, is what he argued the cooperatives were doing; 1990, p. 258). Tax exemptions are therefore a kind of penalty on those who can’t obtain them. I should note that this is not necessarily a defense of Mises’s views on this point, merely an explanation of his position.
(As an aside, the Carrier deal has once again raised the question whether tax exemptions are actually subsidies. Mises’s terminology is inconsistent on this point. In some places he lists exemptions and subsidies separately as different examples of privilege [1990, p. 247], while in others he refers to exemptions as “virtual subsidies” [p. 258], and in others still simply as “subsidies” [p. 259].)
The Politics of Tax Deals
In addition to the argument from fairness, however, Mises also noted the political problems of tax policy. Like any good economist, he stressed the importance of the “unseen” effects of targeted tax breaks. Specifically, he recognized that, sadly, the recipients of tax exemptions do not simply accept them and move on, much less try to extend them to other entrepreneurs. Instead, once they have the ears of policymakers, businesses are likely to use their privileged status to seek more harmful forms of support from government. For example, Mises rarely mentions tax privileges alone; he usually links them to a second, related policy: cheap government credit (1990, p. 272). Together with direct subsidies and other forms of privilege, tax exemptions and cheap credit provide the basis for policymakers to systematically influence the direction of economic development.
Rather than receiving benefits and using them to help other players, firms are likely to do just the opposite: band together with various politically-connected organizations to prevent outsiders from gaining similar advantages, especially by imposing further restrictions on them. Businesses use their political networks to keep tax exemptions for themselves, while shifting the burden of taxation to other groups, especially their competitors (1990, p. 264). The choice then is not between no tax relief and a small amount of tax relief, but between exemptions for one group or another.
Here we return to Trump’s recent deal with Carrier. There’s every possibility that his exemptions for specific firms won’t pave the way for more exemptions, but fewer. Yet this is not an argument for taxation. If anything, the failure of these politically-convenient tax deals only shows why the gradualist approach to economic reform doesn’t work. By singling out firms for special treatment, government welcomes them into the interventionist fold. From there, as Mises recognized, the political sphere begins to take control. Without sweeping reforms, marginal improvements quickly become conventional cronyism. Promises of tax relief are rarely genuine, and when they are, there are almost always hidden costs in the form of increased political entrepreneurship and the expansion of regulation. We have little reason to think things will be different with the Carrier deal.