Tax Subsidies for Debt

This week’s James Suroweicki column takes on the subject of America’s hefty tax subsidies for debt, specifically the way that interest payments are tax deductible for businesses and mortgage interest payments are tax deductible for individuals. The hook for this, and for Felix Salmon’s followup, is largely the idea that “too much debt” (and too much house-buying) led to the economic crisis. I’m not 100 percent certain that’s right* but it’s worth noting that this is a pretty bad idea even if it’s not directly responsible for any particular cataclysm.

Our political culture is highly biased in favor of tax cuts, which leads to a lot of subsidies being doled out that nobody would take seriously. If I said “every time a business makes $1 in interest payments, we should give them a quarter and pay for it with higher overall corporate tax rates” nobody would think that made sense. But this is a pretty general problem, and as Suroweicki notes in a followup post the difficult political problem becomes specifying the alternative. Any proposed change naturally gets into an ideological tug of war between people who want to make overall taxes higher and those who want to make overall taxes lower. That, combined with a political system with tons of veto points, makes things easy for special interests who want to block change.

But as long as Washington is full of talk about a bipartisan deficit commission, it seems to me that a tax reform commission is what we really need. A nice big chunk of the deficit problem is going to need to be handled through higher taxes. If we increase revenue while also increasing the efficiency of the tax system, I think that’ll be fine though people will obviously complain anyway. But if we just increase rates while also continuing to add more and more loopholes and deductions and exemptions, we’ll be making a lot of problems worse.

* It seems to me that there’s a case to be made that in the absence of a tax subsidy for debt, the price of borrowing would have been even lower creating similar incentives to over-leverage. The real subsidy was probably received by people in the past. This seems pretty clear in the case of houses. When I was buying, sellers kept emphasizing that thanks to the tax benefits such-and-such a price was really more affordable than it seemed. Which is true. But if it hadn’t been true, it would have been true for all potential buyers and the market-clearing price would have been lower.