Tax Rebates Redistribute Wealth

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The tax rebates contained in the Economic Stimulus Act of 2008 were controversial because most economists doubted they would fire up the national economy enough to justify their cost.

Less controversial, however, was the fact that once Congress and the President decided to go ahead with the program they made it means-tested, that is, they excluded high-earners based on a complex formula. Thus, a married couple with one child saw their $1,500 stimulus payment reduced starting at an adjusted gross income of $150,000 and completely disappear at $180,000 of income. As a result, households which pay the bulk of taxes (those making more than $150,000 a year pay 60 percent of income taxes but constitute just 5 percent of taxpayers) got the least benefit. And they will undoubtedly pay most of the future cost of the program, especially if a yet-to-come president raises taxes to reduce a federal deficit that has grown larger because of the rebates. Consider the means-tested 2008 rebates, then, a kind of stealth form of income redistribution.

In this, we can say that federal politicians are learning from their state and local brethren. Although tax rebate programs are relatively rare at the federal level (though we’ve now had two in the past seven years), they are increasingly common at other levels of government and almost invariably now exclude certain taxpayers, namely those doing well. Although these programs are not nearly as controversial as redistributing income by raising taxes on the rich, the effect is similar. Given how politically popular such rebates have become, expect even more of them, and expect those with the highest income to bear their burden.

Unlike the federal stimulus package, one purpose of local rebate programs is to refund to taxpayers a portion of embarrassingly high budget surpluses, and thus defuse calls for permanent tax cuts. And so, when New York City logged a budget surplus just a year-and-a-half after Mayor Michael Bloomberg pushed through the largest tax hike in the city’s history, Gotham began a rebate program that it renews each year in lieu of simply cutting taxes. The rebates allow Mayor Bloomberg and the city council to target the money where it does the most good politically by reserving it for homeowners, even though businesses paid the bulk of the additional taxes. The program also affords local pols the opportunity to announce with fanfare a new rebate each year.

Taking a similar approach, New Mexico has decided to refund some $58 million of the state’s current budget surplus to taxpayers, but households earning more than $70,000 a year will receive nothing, and those earning less will see their rebates decline as their income rises. The state’s economy and its budget have done well since Gov. Richardson cut income tax rates across-the-board in 2003, but the federal stimulus package now seems to have inspired New Mexico to go the route of means-tested rebates.

Politicians seem to love such programs so much they are even willing, paradoxically, to raise taxes to support them. New Jersey began a rebate program in the late 1990s when the state was running huge budget surpluses, using state funds to offset high local property taxes. But as Jersey’s spending rose and the 2002 recession cut tax revenues, the state raised dozens of taxes, including those on businesses and high-income earners. But it kept paying out the rebates, as politicians argued that in hard times the refund checks were even more important. Of course, the state eliminated those refund checks for high income earners, the very same people whose taxes it had raised to keep the state’s budget afloat in the first place.

Rebate programs have become an especially popular way to soothe anger over soaring local taxes. Municipalities have long used property taxes to finance most of local government, including schools. But K-through-12 school spending in America has soared, increasing on a per-student basis about four-fold in inflation-adjusted terms over the past 50 years, according to Manhattan Institute senior fellow Jay Greene. Those increases have forced property taxes sky-high and prompted states to step in with means-tested, state-funded rebate programs. Some 18 states, for instance, now have rebate programs that employ “circuit-breakers” that stop refunds once a household reaches a certain income level.

These programs are an easy sell because of the widespread and misleading notion that property taxes are regressive, that is, that they impact lower income households disproportionately and therefore that the rich should help to offset their cost so that ‘working families’ can stay in their homes. This notion remains pervasive even though economists concluded decades ago that property taxes are, in fact, progressive because they generally represent a tax on a household’s true wealth—something that’s not always accurately reflected in other sorts of taxes.

Despite claims by their proponents, most property tax rebate programs don’t really subsidize working families anyway. Most are heavily oriented toward retired senior citizen homeowners, who are reliable voters, on the spurious notion that those on a fixed income are hurt most by such a ‘regressive’ tax. But income is a poor measure of household wealth. Although the typical over-65 household earns only half the annual income of a household headed by someone aged 35-44, senior households also have an average of three-times the assets of these younger families, and far fewer family members to support. Still, virtually all property tax rebate programs take tax money paid by our most productive workers and use it to relieve the burden of those who are no longer working, but who may have spent a lifetime accumulating wealth.

Even worse, rebate programs designed to ameliorate the burden of higher taxes rarely get at the underlying causes of the problem—government spending. A study a few years ago, for instance, found that municipal governments in New York State had accelerated their spending after the state instituted a rebate program to offset rising local taxes, and the higher spending prompted even faster growth in municipal taxes within a few years. Critics of rebate programs had warned that just such a thing would happen unless the state enacted spending caps. But while refund checks are popular, spending limits are vigorously opposed by public sector unions and local politicians. So, like many rebate programs, New York’s was an example of the worst of both worlds.

That’s a good way to describe the impact of tax rebates on businesses and high income families: the worst of both worlds. Expect these means-tested ways of redistributing income to become ever more common.

Steven Malanga is an editor for RealClearMarkets and a senior fellow at the Manhattan Institute

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