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March 1996
Volume 14, Number 3

Taxes and Distortion
Llewellyn H. Rockwell, Jr.

The government always wants more of our money, and too many economists are ready to make the case for surrendering our last dime. During the budget hysteria of 1990, for example, many economists claimed that the government needed to raise taxes to balance the budget. Anyone who disagreed was supposedly unwilling to confront the hard fiscal reality that the public needed to be taxed more.

Five years later, spending and taxes were higher than ever, and the deficit still giant. Meanwhile, these economists didn't repudiate their bad advice. They had moved on to denounce the per-child tax credit, which they called an "expenditure" that "we" can't "afford." It would cause "distortions" in the market and wouldn't help economic growth.

Economists who serve as the government's intellectual shocktroops don't want people to be allowed to keep more of their own money. The particulars don't seem to matter. Outside the Austrian School, few economists have any kind words for tax breaks. Likewise, they can't praise tax increases enough, for a tax increase, they promise, will balance the budget, though it never does and never will.

Surely no tax deduction has been so despised by non-Austrian economists, but loved by everyone else, as the home-mortgage deduction. Just as quickly as the child tax credit took a dive, a new hysteria began, this time to repeal one of the last remaining tax breaks for regular Americans.

This deduction, we were told, is a terrible remnant of a bygone era when tax policy encouraged people to buy homes. This "bias" in the law has caused a "distortion" in the market by "subsidizing" home purchases. For that reason, the tax break must be repealed, the distortion eliminated, and the middle class made to shape up.

How will this affect the home prices and the real estate market in general? Not at all, these economists say. Homes will be more affordable because interest rates will fall. What they don't explain is how this "distortion" can be eliminated without causing a decrease in the demand for housing, and thus a fall in housing prices and an industry-specific downturn.

In fact, there is nothing horrible or distorting about people spending their own money on something they want, which in this case is homes. A tax break cannot create a demand for a product. It only makes a product slightly more inviting to purchase as compared with more highly taxed alternatives. The real "distortion" is not the tax break but the remaining high taxes.

Neither can a tax break be called a subsidy. People can deduct the interest, but that's not the same thing as taking other people's money. It means that a tiny bit of income is sheltered from the tax police.

And why is this the only remnant of the old days that we are supposed to repeal? Why not Fannie Mae, Freddie Mac, Ginnie Mae, FHA, and VA subsidized mortgages? And if we are worried about "subsidies" to housing, why not stop funding the gigantic public housing industry? Or why not save $30 billion and abolish HUD, big housing's best friend?

No, that's not part of the discussion, even though these remnants do distort the market by using tax dollars to promote and finance mortgages, and construct free homes.

If economists worry that the mortgage-interest deduction causes more single-family houses to be bought than apartments rented, there's a way out. Introduce a deduction for rental payments, so there's no financial advantage to buying over renting. But the fact that this is ruled out shows that the real bias is toward helping the government.

Since repealing this tax break is the same as increasing taxes, it is doubly irresponsible for economists and politicians who claim to favor free markets to add their voices to the chorus of deduction haters. Repealing deductions doesn't make the market more free; it only leads to more plunder of property owners and less prosperity.

But if the mortgage-interest deduction is repealed, won't interest rates go down? Not necessarily. It is impossible to look at, say, a 7% interest rate and know how much of it is the "real" rate, how much is the inflation premium, and how much is a result of tax policy.

Predictions about falling interest rates are as likely to come true as any other econometric prophecy. We can only know that we will be denied one of the few remaining windows of tax freedom left in American life.

Notice too how economists who gripe about the "distortions" of tax deductions never bring up the distortions of taxes. The income and social security taxes, which together can rob America's most productive citizens of up to half their earnings, discourage work, saving, and investment, and act as a drag on economic growth.

The words distortion and taxes are inseparable. Medicare taxes reduce medical savings. Excise taxes discourage production of the good being taxed. Inheritance taxes cause people to shorten their time horizons and drain savings before death. Nanny taxes reduce the amount and quality of child care.

The average American works 171 days, from January 1 until June 20, just to pay his taxes. We hardly ever hear about this distortion, while the fact that people are allowed a little tax freedom when they buy a house causes a frenzy.

It just goes to show, once again, that America has produced no greater crop of liars and scoundrels than most economists, ever anxious to give the government more power and always ready to offer a pseudo-scientific excuse to reduce our liberties.

Alone among those running for president, Steve Forbes dared question the idea of revenue neutrality (code for: "the government's income can never be allowed to fall"). Good for him: his proposal for lower taxes--as versus just shifted-around taxes--stole the show because it was exactly what overtaxed Americans wanted to hear.

But he undermined his message by calling for the repeal of all remaining tax deductions, including the charitable deduction. Predictably, bad economists also denounced this deduction, and assured us that its repeal would eliminate another "distortion."

In an age of Leviathan, with falling living standards and ever-higher taxes, there's only one kind of tax reform worth pursuing: that which gives us lower and lower taxes until freedom, prosperity, and private property are again safe from the government. Only when taxes are no longer a burden on business and families can we say that real distortions have been repealed.

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Llewellyn H. Rockwell, Jr. is president and founder of the Ludwig von Mises Institute

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