Episode 8: Does the Tax Law Signal Change in How Parties use Tax Credits and Deductions?
The U.S. has a long history of spending through the tax code, limiting revenue to provide benefits. But Congress just passed a major tax cut that limits some tax deductions, keeps others, and expands the child tax credit. How do the latest Republican efforts fit historical patterns? Christopher Faricy‘s recent article finds that Republicans usually limit credits and expand deductions, whereas Democrats do the reverse. Yet Joshua McCabe’s research finds that the child tax credit is historically a Republican policy; but its targeting is limited by a debate focused on tax relief rather than income supplementation. Both say the latest law could limit the value and political salience of major tax deductions.
The Niskanen Center’s Political Research Digest features up-and-coming researchers delivering fresh insights on the big trends driving American politics today. Get beyond punditry to data-driven understanding of today’s Washington with host and political scientist Matt Grossmann. Each 15-minute episode covers two new cutting-edge studies and interviews two researchers.You can subscribe to the Political Research Digest on iTunes here.
Grossmann: This week on Political Research Digest: How the Parties Use Tax Expenditures to Benefit Their Constituents, and Why They’re Debated as Tax Relief and not Income Subsidies. For the Niskanen Center, I’m Matt Grossmann.
The U.S. has a long history of spending through the tax code, limiting revenue to provide benefits. But Congress just passed a major tax cut that limited some tax deductions, kept others, and expanded the child tax credit. How do the latest Republican efforts fit historical patterns? A recent article, The Distributive Politics of Tax Expenditures, How Parties Use Policy Tools to Distribute Federal Money to the Rich and the Poor, published in Politics, Groups, & Identities, argues that Republicans tend to support deductions whereas Democrats tend to pass credits, both to benefit an unpopular party constituency. I talked to author Christopher Faricy of Syracuse University about what the latest bill continues and changes.
In a big last-minute step, negotiators agreed to make more of the child tax credit refundable for those without income tax liability. I also talked to Joshua McCabe of Endicott College about a recent article he coauthored with Elizabeth Popp Berman in Sociological Science, called American Exceptionalism Revisited: Tax Relief, Poverty Reduction, and the Politics of Child Tax Credits.
They find that Americans have long debated policy as either tax relief or welfare, rather than supplementing incomes, based on how the policies were initially set up. Men making the U.S. credit comparatively stingy. Political scientists traditionally find that Republicans focus on lowering tax rates, but there is a lot of action on the tax expenditure side. Chris Faricy says both parties use tax breaks to benefit their constituents.
Faricy: They use them for political purposes to distribute government benefits to groups within their electoral coalition that aren’t very popular with the general public. So they’re able to kind of pair this very popular mechanism, a lot of people are in favor of tax breaks, with distributing money to groups that are not as popular, but important to their politics.
Grossmann: But their different constituents imply different designs.
Faricy: Tax breaks can be designed different ways, as a credit, as a deduction, as an exclusion, as an exemption, and the way a tax break is designed has different distributional consequences. So something that is an exclusion or a deduction is more likely to help wealthier people because it’s levied against the progressive income tax code, and something that’s a credit’s more evenly applied, and refundable credits even give people money back after their whole tax liability is expunged, which tends to help working class families.
What I’ve found is that Republicans are more likely to, when they’re in power, expand exclusions and deductions, whether measured by the number of programs that are added or by the value of these existing programs. And Democrats expand credits.
Grossmann: Faricy says, despite claims of reform, the latest bill generally fits these patterns.
Faricy: Where it falls into this pattern is that there were creations of new deductions, like the past due deduction, there were expansions of existing deductions like the 529’s, which are now going to be allowed to be used for religious schools and private schools and home schooling. The credits that were included in this bill [inaudible 00:03:29] in 2025 …
Grossmann: But he acknowledges that the tax credit and some limitations were new.
Faricy: There was the expansion of the child credits, there were some deductions that were curbed like the home mortgage interest deduction to help pay for some of the changes on the corporate side.
Grossmann: The limitations were in service of lower rates overall.
Faricy: I think that Republicans have shown a willingness, past and present, to stem deductions when the overall bill cuts rates that in turn favor wealthier individuals or businesses and corporations. As long as the overall bill is reducing tax liability and reducing it more for folks at the top, then I think that sacrificing a deduction here or there is a trade Republicans are more than willing to make.
Grossmann: And we can also learn a lot from what they chose not to do.
Faricy: I think that they found that some of the early talk about really limiting the home mortgage interest deduction didn’t survive some of the lobbying barrage that occurred during the final month of the negotiation. There were changes to SALT, but SALT even survived in some form with the either/or $10,000 option that was levied by Republicans from New York and New Jersey and California.
Originally there was talk about reform, there was talk about being able to limit tax expenditures and deductions and exclusions and exemptions enough where you could do your taxes on a postcard, and that really didn’t come to fruition at all. If anything, the tax code is gonna be more complicated after the passage of this bill than it was before.
Grossmann: Democratic tax bills tend to look a lot different.
Faricy: The major provisions in both the Affordable Care Act and the stimulus were all credits. You have the refundable tax credit for people buying health insurance on the markets, you have the tax credit for small employers, part of the ACA and part of the way that they paid for that they had a limit on the medical deduction. And with the stimulus package, again another major provision of that was the making work pay tax credit.
I’d say there’s more uniformity in making credits the centerpiece of their legislation on the Democratic side than Republicans relying on deductions when it comes to their tax bills.
Grossmann: Faricy sees tax expenditures as more popular ways to direct benefits.
Faricy: These are remarkably popular, they’re popular across party identification, they’re popular across ideological leanings. The popularity of these does incentivize policy makers to use them over traditional forms of spending.
Grossmann: But the approaches also match each party’s philosophy.
Faricy: Democrats believe that if you give money to the middle and working class that consumer spending is 66% of GDP, and they’re gonna spend more of that money than they’re gonna save, and that is a way to really grow the economy. Where, conversely, I think a lot of Republicans really believe that if you give more money to people who are business owners and who own capital, that they’re going to use that money to hire workers, to buy machinery, and again that that is the best mechanism to grow the economy.
Faricy: So I think there is an honest economic divide which these two types of tax breaks align well with.
Grossmann: Either way, the U.S. has ended up with a lot more tax expenditures than other countries.
Faricy: The United States was at 2% of GDP, and I think the next country was Germany at 1%, and then most of the other OECD countries, their total tax expenditure value on an annual basis was under 1%. I still think that as far as using this as part of our policy, that it’ll be a more central part of our policy than other European nations, and again there really wasn’t an effort like there was in 86 to try to curtail or end a lot of these in exchange for reduced rates.
Grossmann: Looking comparatively, Joshua McCabe finds that Americans have long viewed credits as part of tax relief because they lacked a post-war family support tradition.
McCabe: There are three ways to look at what a child tax credit does. And I talk about three logics in the paper, the first is this logic of income support, what we typically think of as welfare. The idea is that people will support giving money to poor families as long as they think they’re not able to get a job. We tend to think people hate welfare, but they just think that only certain people should get welfare.
And then there’s this logic of tax release, that we think you shouldn’t tax people into poverty. We usually see this with dependent exemptions, this idea that people shouldn’t pay taxes until they make a certain amount of money to support their family.
And up until World War II these were the two logics that governed social policy in the U.S. and Canada. During World War II, a third logic emerged in Canada but not the U.S., and we call this the logic of income supplementation. This is the idea that if you want a functioning welfare system, or social insurance system, that wages don’t take account the number of children you have. So if you don’t want people to end up on unemployment insurance and not able to get a job again, then you need to supplement families with something like a family allowance.
Grossmann: As a result, we’re now exceptional in our lack of income support.
McCabe: In the U.S. we never had a family allowance. When families and anti-poverty advocates and poor family advocates that are looking for the economic pressure on families, what’s that source, they look to the tax system. Eugene Steuerle, a famous economist, write this report in 1983, and he shows that the tax exemption for children has corroded in value by 50% since 1948.
And a lot of policy makers and think tanks jump on this as the source of economic pressure on families, they say the reason families aren’t doing so well is because taxes have gone up. Typically, we think of this as a right wing position, but the interesting thing I found was that two groups really jumped on this. The first was social conservatives, and they were mostly concerned about family stability and making sure families could stay together and make it. They weren’t anti-tax per se, but they had this report telling them that the tax system was the source of these problems, but it became anti-tax.
The second one is anti-poverty liberals. Again, they’re not anti-tax per se, but they see this as a way to talk about working class issues that makes it more competitive with Republicans.
Grossmann: McCabe says the recent tax bill mostly fit these patterns.
McCabe: The most recent debates as far as I can tell were in line with this logic of tax release. During the election, candidate Hillary Clinton had proposed a child tax credit expansion, but I believe it would go to families who weren’t paying any income or payroll taxes. And she was largely attacked for it.
Marco Rubio and Mike Lee had a similar one that was framed as refundable against income and payroll taxes, and they did a lot better. There was some pushback from conservative business groups who argued that the only real tax release is income tax release, and that the payroll tax release was not true tax release, that it was just another form of welfare.
Grossmann: But he says the child credit is a big exception to Faricy’s finding that Republicans avoid credits.
McCabe: The child tax credit, which is I think one of the most important tax expenditures in the last 20 years, was from the beginning a Republican idea. Most people don’t realize it was a family research council, it was in the contract with America, they see this as a Democratic idea, but it’s really a conservative Republican idea.
And on the flip side, I think we’re seeing changes now where some of the biggest defenders of regressive tax deductions, including the mortgage deduction, the state and local tax deduction, 529’s, have actually been Democrats and sometimes liberal Democrats who see it as an attack on their constituents.
Grossmann: Overall, he says America’s high reliance on tax expenditures is mostly due to old exclusions rather than newly enacted tax credits.
McCabe: The reason the U.S. has more tax expenditures isn’t because they were enacted, it’s ones that were haphazardly put in the original income tax act, and for a whole bunch of reasons unique to American institutions they’re really hard to take out. So the ones for health insurance, for mortgage deductions, for state and local tax deductions, those are the really large tax expenditures that make the U.S. unique.
In terms of child tax credits, the U.S. is actually not unique at all. If you look at every other English-speaking rich democracy, they have tax credits as well.
Grossmann: And the U.S. child tax credit stands out mostly for not being targeted at the poor.
McCabe: In terms of the timing of the development and their use across other countries, the U.S. is very similar. The only difference is who qualifies for the credit and who doesn’t. In that case, the U.S. is unique in that it excludes the poorest families from benefiting from this credit.
Grossmann: McCabe does not see it as a racialized or religious issue in the U.S.
McCabe: Countries like France, who historically have been very Catholic and want people to have lots and lots of babies, the family allowance has been something that they’ve used to try to push people to have more children. In the U.S. and Canada it was actually the opposite, that they worried certain people would have babies and others wouldn’t, so they at first tended to shy away from family allowances, and this is the interesting thing about Canada, if you look at the historical record, when they first introduced family allowances or proposing to do so they worried that certain races would have more children because of the highly racialized anti-Catholic sentiment.
But they soon got over those worries only after the policy was introduced. So the idea that American racism is unique and can explain why we don’t have a history of family allowance doesn’t hold up when you look at Canada.
Grossmann: The latest approach continued the logic of tax relief, but tried to extend refundability to payroll taxes. But the room for that argument will soon run out.
McCabe: After Rubio leaves we’ll reach a crossroads where income and payroll taxes are the two main sources of federal taxes on families. Once the child tax credit becomes fully refundable against both of those, it will leave families with little federal payroll tax liability.
So the question becomes, “Is this the end, or are policy makers able to reframe the child tax credit as something else, as an income supplement rather than as a form of tax relief?”
Grossmann: So what will the future bring? Faricy sees room for policy feedback from the latest bill.
Faricy: Right now, only 30% of people itemize as it is. So if you reduce that number to 15 percent, 10 percent, then really over time tax breaks and these tax expenditure programs might become associate with a certain kind of rarefied socioeconomic class, and people won’t go through the annual process of having to learn which programs that they qualify for, and which programs that they use, and therefore it might create more of an out-group versus ingroup.
Grossmann: McCabe adds that, over time, as the value of tax deductions decline, their constituencies could fade.
McCabe: They lowered the cap on the mortgage deduction but they didn’t totally eliminate it. They also capped state and local tax deduction without totally eliminating it. And a lot of people see these as policy failures, but given the strength of these two deductions and how many times they’ve survived attempts on their lives, I think this is a real step forward because those caps aren’t indexed for inflation, so over time the value of these deductions will decrease in conjunction with the increase in the standard deduction, you’ll have less people itemize.
So political science has called this policy drift, where no one actually makes any changes from here on out, but they let inflation do the work of eroding these benefits to become weaker and weaker, and at some point in the future I think the Republicans will completely get rid of the state and local tax deductions and the home mortgage interest deduction.
Grossmann: Faricy says Republicans could even lose their traditional ownership of the tax issue.
Faricy: I think that the ownership is fading in a sense that there is probably a natural political limit to how many decades you can promise to lower people’s taxes to the point where they don’t feel it is an issue that is failing us anymore. Or, if they feel that the taxes being lowered are really going to improve their day-to-day lives.
Grossmann: The next step for McCabe is to look comparatively at major tax deductions.
McCabe: My next project’s to look at the mortgage interest deduction and then look at the state and local tax deductions. The big question now is how do we get rid of the mortgage interest deduction? Most economists hate it, I think all sociologists hate it, yet we still have it. In this case, comparative analysis can shine light on it by looking at countries like the United Kingdom which once had a mortgage interest deduction but they slowly got rid of it between 1974 and 2000 was when they finally eliminated it altogether.
So for me, looking at countries that have a similar policy as the U.S. but go in a different direction can shed a lot of light on how you can change things in the U.S.
Grossmann: Faricy says his next step is to look at the effects of tax expenditures on any quality in wealth.
Faricy: There’s been a lot of focus in political science on income inequality, but less on wealth inequality which is larger. And most of these provisions deal with assets and capital and people’s ability and families’ ability to, not only generate wealth, but then pass that wealth on. There’s a big wealth gap in the United States, and the wealth gap is particularly pronounced by race and ethnicity.
Grossmann: There’s a lot more to learn. Political Research Digest is available biweekly. From the Niskanen Center, I’m your host Matt Grossmann. Please encourage others to subscribe on iTunes and read more at niskanencenter.org. Thanks to Christopher Faricy and Joshua McCabe for joining me. You can join us next time to find out whether the parties are losing control of their congressional primaries, and how they’re fighting back against insurgence.