Cronyism and the Tax Code

Thanks to the surprising election of Donald Trump and the Republicans ability to hold both chambers of Congress, the reality of tax reform is a topic in Washington, DC that has been the focus of a number of events since the election. It has been thirty years since the Tax Code underwent real reform, and since 1986 it has only grown in length and complexity. Today the code is over 70,000 pages long and requires 8.9 billion hours of labor per year, at a cost to the economy of nearly $234.4 billion per year.

According to the Charles Koch Institute’s Dana Wade, a major reason for the growth in the length and complexity within the Tax Code is cronyism, or corporate welfare. It should be noted that not all tax deductions or exceptions are cronyism. The difficulty of dealing with this issues is determining what is a proper tax cut to mitigate bad tax policy, like doubling taxing, and what is cronyism. Their are some tax credits, like the Child Tax Credit or the Earned Income Tax Credit, that while some would argue should be eliminated, they are not cronyism.

The Mercatus Center has properly defined cronyism as “privileges that governments give to particular businesses and industries.” These privileges are usually granted because large industries and interest groups lobby the federal government for them. This explains why corporations spent $2.6 billion in lobbying expenditures in 2015.

Over the past 30 years industries and interest groups have convinced Congress to include special benefits and tax preferences within the Code just for them. In other words, tax rates for some businesses and special interests are not set in stone, but are ultimately dependent on how well they can lobby the government for special favors. This has been especially advantageous for larger or prosperous businesses and well-connected special interest groups, but harmful to smaller and less influential businesses and interest.   

Currently, cronyism dominates the Tax Code with an existing number of narrowly tailored tax deductions, exemptions, credits, and deferrals that benefit small, but influential special interests. Usually those benefiting from and lobbying for special tax privileges are not average taxpayers, but taxpayers who have a considerable amount of wealth. For example, there are tax preferences in the code to benefit horse racers by allowing a 3 year depreciation schedule to apply to all racehorses and allows any investment in racehorses to be immediately depreciated up to $500,000. This special tax treatment has been proudly championed and lobbied for by the American Horse Council.

Also, there is the Second Generation Biofuel tax credit that allow special tax treatments to producers of “liquid fuel produced from any lignocellulosic or hemicellulosic matter that is available on a renewable basis or any cultivated algae, cyanobacteria, or lemna.” Produces of second generation biofuels can receive $1.01 per gallon from the federal government for biofuel sold. Some people can combine this tax credit with the alcohol fuel tax credit to receive additional preferential treatment from the federal government. These tax credits are perfect examples of concentrated benefits for special interests.  

Even the slightest tax preference granted by the government distorts the market. If the government has already determined that a certain fuel type is better than another, then producers of differing fuels are disincentivized to compete and improve their product. Instead, they will just leave the market or transition to producing the subsidized or tax preferenced fuel.

For example, Nevada’s legislature created a special tax preference for lithium battery production worth over $1.3 billion to entice Elon Musk, the co-founder of Tesla Motors, to build his lithium batteries in their state. According to the American Enterprise Institute’s Timothy Carney, producers of batteries who had been experimenting with several types of battery power abandoned their testing of those battery types and focused on producing lithium in order to benefit from this massive tax break. Who knows what could have developed from those battery tests. 

Additionally, these tax preferences for Tesla and those who purchase them are benefiting people who can already afford a $70,000 vehicle; they are not broadly benefiting the average American. These kind of antics are what stand in the way of a fairer and simpler Tax Code. As Phil Kerpen notes in the National Review, “Tesla has effectively socialized its costs through subsidized loans, tax credits, abatements, and regulatory schemes while privatizing its gains… .”

Individuals, not government, should be able to reward businesses that create the greatest amount of value in society and meet the needs of their customers. Businesses have to be responsive to the concerns and desires of their customers or they will not be in business for very long. However, if a business is functioning with a poor business model or is not creating value in society, but has the backing of the government, it can continue to produce unneeded or unwanted goods and services without being properly punished by the market.

Tax reform that establishes flatter, lower rates will reduce the prevalence of cronyism in the system. The next administration must not back away from tackling cronyism, regardless of how much industries and special interests claim that tax preferences are necessary. Tax reform should focus on lowering tax rates across the board, broadening the base, and removing unfair government-granted privileges.