I had set President Obama’s State of the Union proposal on 529 plans to one side to read and think about later, but now I see that he’s already killed it.

Soon I’ll write a proper review of Kleinbard’s [book: We Are Better Than This], which goes into this sort of thing in great detail, but: the opposition to Obama’s plan seems like a great example of tax illiteracy. Maybe it’s also a problem of impolitic presentation on the president’s part; I’m not sure. But there are a few things that absolutely need to be pointed out:

  1. Any kind of benefit that comes to you in the form of a tax deduction helps the wealthy more than it helps the poor. If you spend $18,000 a year on mortgage interest, and your top marginal tax rate is 28%, then you get to spend $5,040 less on your taxes every year than you would in the absence of the mortgage-interest deduction. Whereas if you make a bit less money and are in the 25% bracket, you get to save $4500 on your taxes. The wealthier person saved $500 more than the poorer person for the same mortgage.

    The same is true of the health-insurance deduction: if you get insurance through your employer, you don’t pay taxes on that benefit, even though it’s basically a form of cash; and wealthier people get the same insurance more cheaply than poorer folks. This even holds within the same company: even if the CEO and you use the same health-insurance plan, he’s getting it more cheaply than you are, thanks to the tax law. (Kleinbard himself went through this example a year and change ago.)

    (Worth pointing out: just as the deductibility of health-insurance benefits encourages us to spend more on health care than we otherwise would, so the mortgage-interest deduction encourages us to buy larger houses than we otherwise would.)

  2. Many of the benefits that come to us through tax deductions encourage people to save, and those people often turn out to not need the encouragement. 401(k)s are a great example here. I, personally, save the legal maximum in my 401(k), but I would be saving that money some other way if the 401(k) weren’t pre-tax. So I’m getting a tax benefit, and for what? To encourage me to do something that I’d do anyway. The government shouldn’t be in the business of giving people money for no benefit.

  3. When we encourage behavior through tax deductions, we can pretend they’re not actual expenses. Here’s how to help middle- and low-income kids afford college: pay for them to go to college. Or better yet, run public universities and community colleges directly. But if we did this, there would be a cost on the books, and our elected representatives (and many Americans, I suppose) hate to spend money on things. So instead we give people tax deductions, which suffer from all the problems I’ve mentioned above; then we can pretend that these aren’t real expenses.

    This spending is called, instead, a “tax expenditure”, and we’ve only been tracking it since 1967. Better yet, I discovered from Dr. Kleinbard that we undercount tax expenditures: we count the lost income tax, but we don’t count the lost Social Security tax. So when people talk about how “Social Security is going broke,” a large part of the blame can be laid at the feet of our health-insurance and mortgage-interest deductions. If I understand the accounting properly, the health-insurance deduction costs about $100 billion in Social Security taxes annually. Think about how much more easily we could shore up the Social Security Trust Fund if we put that back on the books.

    I can hear one objection already: “That’s the taxpayer’s money. Don’t pretend that the government ‘deserves’ that money.” That’s a fair objection, but my point is not that one side or another deserves the money. My point is that if we’re going to spend money, we should be honest about what we’re spending. Instead we’re patently dishonest: because we’ve developed a public allergy to spending money on things, we hide our spending in the form of tax deductions. Somehow a dollar of foregone tax revenue doesn’t count the same as a dollar of direct spending. So we opt for subterfuge. (I got a review copy years ago of [book: The Submerged State], but never got around to reading it. My understanding is that it makes this point more broadly.)

My point, and I think President Obama’s, is that if we have to spend money, we should spend it honestly, should spend it wisely, and should spend it progressively. If the goal is to encourage middle-income families to send their kids to college, and if we feel we must make this happen through the tax code, then give people a tax credit that doesn’t increase with income. Better yet, spend the money directly rather than hiding it in a tax expenditure. And don’t give people a tax-advantaged way to save when those people would already be saving money even without the tax break.

This is all common sense, yet I’m coming to the sad conclusion that we as a country like to be lied to. Not only that, but tax policy is boring. To paraphrase Leon Trotsky: “You may not be interested in tax policy, but tax policy is interested in you.” I hope there comes a point when we grow up and pay attention to how our nation is being mismanaged.