It seems like a good idea to make policy through the tax code. After all, everybody pays taxes and everybody hates taxes. Plus you can count your policy as a tax cut (yay!) instead of more wasteful government spending (boo!) or (god forbid) welfare. A recent Bloomberg piece demonstrates the issue with this:
The real estate levy, the city’s biggest revenue source, uses a methodology that undervalues condominiums on Park Avenue, Central Park West and other enclaves of the wealthy; limits tax increases for owners in brownstone neighborhoods such asGreenwich Village and Park Slope; and shifts the heaviest burden to renters, many of them poor.
For New York City and neighboring Nassau County, the  law created four classes of property — one- to three-family homes, apartment buildings, utilities and commercial property — with each taxed under different formulas.
The intent was to lock in the percentage of total property-tax levy paid by each class at the 1981 level. That gave homeowners an advantage because historically they had received bigger breaks than other properties.
Ugh. Giving homeowners a ceiling on their tax burden certainly sounds like a nice idea. There are three fundamental issues with deciding to do this sort of policy through the tax code.
- Benefits the rich. The majority of tax benefits go to people who have the heaviest tax burden. Seems natural, but if you try and imagine this as a spending program it’d be pretty bizarre. New York gives the most money to people who already have the most money…wait, isn’t that the opposite of how this is supposed to work?
- Advantages the savvy. A closely related issue – not everyone takes advantages of tax benefits. Generally because they’re extremely opaque and confusing, a fact the Bloomberg piece discusses. The people who do take those benefits home are the ones who know about them and have good tax accountants. The people who need the money most are least likely to know about it or to fill out the forms properly.
- Bad policies never die. If New York City had a line item in its budget giving out free money to rich homeowners it would last until the next Democratic primary. It’d be a self-evidently insane policy priority in a city where nearly two million people live in poverty. Yet because it’s embedded in the tax code this policy of “free money for rich people” just keeps chugging along.
If there’s anything the American tax code can teach us, it’s that our mistakes stick with us. We should be very, very apprehensive about making policy through “narrow and targeted tax cuts”.
Warning – this is a post without empirical evidence.*
One of the most frustrating things ever is hearing the argument that tax incentives will bring startups to Our Depressed Rust-Belt Mid-American City. First of all, startups won’t replace the thousands of jobs lost when the old
cancer paper mill closed down – startups will employ far fewer people, and they will be mostly importing their talent from other cities/states/countries. That’s not terrible – those employees will still need meals cooked, lawns mowed, clothes cleaned, etc. The ancillary jobs of a thriving startup scene are often decent ones – but the good high-paying jobs won’t go to locals. No, the real issue with these policies is thinking that startups make decisions based on taxes.
A startup is a machine designed to turn ideas into products, and sometimes products into revenue, and products + revenue into growth. Notice a very important word that isn’t in that description? Profits. Very few startups are profitable from the get-go, and most aren’t meant to be – even the ones with massively positive cash flows show little or negative accounting profit. That’s because all of that cash is shoveled into growth. People starting startups couldn’t give two shakes about the statutory corporate tax rate because you need profits for taxes, and profits are unimaginably far away. When and if a startup becomes big enough to become profitable, it’ll already be domiciled someplace exotic with nice weather, secretive banking laws, and even more flexible tax codes.
There are tax incentives startups would care about a lot – incentives that make hiring talent cheaper. Rebates for payroll taxes are one very promising avenue. Today, payroll taxes are split half and half between employer and employee – for employers, it’s a tax on hiring people, and for employees it’s a flat tax on pay. If a local government offered payroll tax rebates to startups, that’s huge – it makes it cheaper for you to employ someone, and it makes their salary worth more. That’s actually a competitive advantage that could make it more appealing for a startup to relocate to Our Struggling Example Of Faded Mid-Century Glory And Metaphor For America’s Decline.
Tax incentives are good for existing businesses – but a narrow subset. Mid-sized businesses (small enough to feasibly relocate) with healthy profits (so the tax rate matters). Those are nice to have – but they’re hardly startups, and they’re not the type that grow quickly enough to revolutionize your city’s economy. Cutting corporate tax rates is basically orthogonal to the goal of encouraging startups, and I wish this tired old cliche were tossed out.
*: Don’t you wish more people warned you?