Welfare for the Rich?Are Tax Deductions the Same as Welfare Payments?

Imagine three friends (let’s call them Rich, Poor, and Average) share an apartment and have a strange deal for paying the rent each month. Average pays all the rent, but he collects money from his friends Rich and Poor. However, since Rich makes so much money, they agree that he will pay most of the rent. Each month, rent costs \$1000. At first, Rich pays \$700, Poor pays \$100, and Average pays the remaining \$200. One day, Poor loses his job and can no longer pay the rent. Average asks Rich to chip in a larger amount to cover the missing \$100, but he also realizes that Poor won’t be able to buy food either. So he asks for \$200 extra and gives \$100 to Poor each month. Now the rental payments look like this: Average pays \$200, Poor pays -\$100, and Rich pays \$900. Rich isn’t too happy with the arrangement, but he agrees since the other friends will kick him out if he doesn’t.

One day, the three friends notice that they need to buy some new furniture. A couch costs \$300. Average tells Rich that if he buys the couch, he will deduct the \$300 for his rent payments for the month. So for the month, the payments now look like: Average pays \$500, Poor pays -\$100, Rich pays \$600 (plus \$300 for the couch).

But then Poor comes to Average and starts complaining. “Rich already makes the most money, and now you’re giving him even more. I only got \$100 from you this month and you gave him \$300. How is that fair? And look, now you have to pay \$500 rather than \$200. If you just hadn’t let him deduct the couch, you could have given me an extra \$100 and kept \$200 for yourself.”

If this argument seems ridiculous read this article that claims rich people get government handouts just like the poor. Notice something strange about this list? Not a single one is actually a government handout. Instead, each is a tax deduction. I only linked to one article, but google “welfare for the rich” and you’ll find many similar ones. But just like in the example above, “welfare for the rich” in all of these cases is simply allowing people who already pay a large share to keep a little bit more of their money. Calling that welfare is deceptive at best. It assumes that the government already has a right to your money. Anything they allow you to keep should be considered a favor.

Let’s put it another way. Imagine there is no government. Everybody keeps everything they earn. Now a single welfare program is put into place where the top income earner pays \$1,000,000 to the lowest income earner. However, mortgage interest is allowed to be deducted so the effective payment only ends up being \$500,000. Soon, the richest guy starts to complain that the system is unfair and that the poorest guy gets \$500,000 without doing anything. The Washington Post writes an article berating the rich guy for complaining. After all, he also receives \$500,000 in handouts from the government in the form of a mortgage interest deduction. Essentially, this situation is exactly what we are dealing with here. If you really think “welfare” for the rich and poor is at all the same there is an easy test: get rid of all government welfare and reduce taxes on everybody uniformly to keep revenue the same (assuming taxes can’t go below zero). Who complains the most?

There are certainly good arguments for why we wouldn’t want to offer tax deductions. They are the same arguments for why we wouldn’t want to tax specific goods. By offering a tax deduction, we distort relative prices as these goods become artificially cheap relative to other goods. If you believe the government can do a good job figuring out which kinds of goods are beneficial for society, these kinds of policies could effectively nudge society towards a social optimum. If, on the other hand, you think government is more likely to make terrible decisions based more on special interests than economic welfare, we’re probably better off keeping deductions to a minimum.

So by all means fight against tax deductions. But stop pretending they are welfare for the rich.

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