The Special Interest Spread

By Henry Oliner

The life force of the swamp is the tax system.  It has grown monumentally complex from the thousands of lobbyist swamp creatures and the thousands of special interests who have learned how to thrive in the hazardous environment.

Reform is hazardous because we can see the existing faults clearly, but the outcome of the change is hazy. The special interests of the swamp fear losing their advantages and protections for a benefit that is unclear and uncertain. We are promised lower rates in exchange for fewer deductions, but we know from experience that when the rates rise again the deductions do not reappear.

The ‘special interest spread’ (my terminology) is the difference between the statutory rate and the actual rate after deductions and credits. In an objective system without the influence of special interests the spread will be close to zero. The spread grows as the government grows and tries to influence our behavior with nudges and policies to encourage select behavior.  Lobbying is a side effect of a government that involves itself in every corner of our lives. Government influence becomes an indispensable competitive tool.

The term ‘regulatory capture’ is a recognition that over time the special interests will begin to control the regulatory agencies that were formed to regulate them.  The agencies become a tool that well-connected companies can use to block competitors.

Tax reform will be difficult because the government operates through so many proxies such as non-profits, lobbyists, employees, consultants and local agencies dependent on federal funding.  It is also very difficult to change a system that has grown so complex. It requires distinguishing the design of an optimal system from the transition to that system.

Theoretically we would be better with far fewer deductions, but there are many homeowners who depend on their mortgage deductions to balance their family budgets.  Grandfathering existing mortgages creates another allocation distorting behavior.  It may also drive down home prices which is great for new homebuyers, but not for those who financed their existing homes. Changes in such complex systems will not come without some victims.

An optimal system is broad, low, permanent, and with a low SIS (special interest spread).  Such a system would require that the government relinquish much of its control over the economy and our lives.  The real loser is not a few special interests losing their precious deductions, but the federal government and the lobbyists who have learned how to maneuver and thrive in the swamp.



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