Tax policy is suffering from a gross problem. Specifically, the problem is a growing bias toward the erroneous notion that the default tax base is denominated in gross income or gross revenue, and that any departures from gross are tax breaks and subsidies.
Once you identify this move, you’ll see it everywhere.
Senators calling for a repeal of “tax breaks” for data centers, where the tax break in question is a first-year corporate income tax deduction for their capital expenditures.
Governors suspending a “tax preference” for businesses, where that preference is the ability to offset income and losses.
State legislators questioning whether it’s appropriate to give an “incentive” to research and development work, when the incentive is the ability to fully deduct compensation costs in calculating taxable profits.
Journalists publishing exposés about “subsidies” for major industries, where the subsidies involve exempting their equipment purchases from retail sales tax.
Activists demanding the closure of “tax loopholes,” where the loophole is that the individual income tax does not apply to accumulated wealth.
Broad bases and low rates are good policy, but broad bases of what? We could broaden the base of the sales tax to include the implicit value of household labor like cooking dinner or vacuuming, since the sales tax already extends to substitutes in the exchange economy like restaurant carryout or hiring a cleaning service. But here, a critic might rightfully respond that what we’re describing ceases to be a sales tax, since it is no longer limited to transactions, which involve exchanging consideration for something of value.
Similarly, including raw materials in the sales tax base or denying a corporate income tax deduction for ordinary business expenses indisputably broadens a base, but what base, exactly? Not a base of “final consumption” (sales tax) or of “net income” (corporate income tax).
I have sometimes spoken of “right-sizing” the sales tax base, by which I mean both (1) exempting more intermediate inputs, because they do not belong in the base of a tax that is properly imposed on final consumption; and (2) including more consumer goods and services that are currently exempted. Of course, “right-sizing” is a value-laden term, though that may be an advantage over another term that I and others also employ: “modernizing.”
I am not willing to give up modernization as an important concept, because I believe it speaks to a genuine issue where tax bases (often by being too specific and targeted) either tax something they shouldn’t tax or exempt something they should, because it doesn’t fit cleanly into outdated categories. In fact, this is a key reason why tax codes should operate at the level of broad principle wherever possible, rather than through specific targeted policies (like incentives for specific industries or activities) that, even if plausibly justifiable initially, may persist long beyond their reasonable expiration date.
But I’m also aware that “modernization” can be a weasel word. A friend at a center-left organization highlighted it as a term he despises at a recent conference we both attended, because who isn’t for modernization? Anything anyone wants to do is modernization. It’s one of those irregular verbs: I modernize, you reform, he carves up the tax code. There’s no question that “right-sizing” embeds strong assumptions, but the term may benefit from wearing those assumptions on its sleeve.
Because what’s often missing in debates about tax bases is any notion that there is a right size based on anything other than a desire to maximize or minimize revenues, as one prefers. We won’t all agree on what the right size is. Nevertheless, to shift spatial terms, each tax has a certain shape. A corporate net income tax where net operating loss deductions are suspended and research expenditure deductions are amortized is less of an income tax, not more of one, even though its base is broader.
Every tax has a conceptual base. The corporate income tax’s ideal base is net income. The sales tax’s idea base is final consumer purchases. I would argue—this would spark more disagreement—that the property tax’s ideal base is real (not tangible or intangible) property.
Agreeing on a theoretical tax base does not settle every question, and no policy realm ever escapes the legislative process entirely pure. Real-world sales taxes apply to far too many intermediate transactions. The corporate income tax delays or disallows deductions that ought to be included. Many states’ property tax bases include tangible personal property, while imposing various distortions on the real property tax base.
Still, acknowledging the basic shape of a tax is essential. A proposal that sweeps away all structural exemptions, imposing sales tax on raw materials, machinery, equipment, distribution, wholesale, retail, and everything in between, is no longer a sales tax. The existing exemptions of intermediate transactions are not carveouts or preferences; they’re what makes a sales tax a sales tax.
When lawmakers debate suspending net operating loss deductions, amortizing research and experimentation expense deductions, repealing sales tax equipment exemptions, or adding new layers of tax on targeted industries, we should reject the framing that these existing policies are incentives, subsidies, handouts, tax breaks, or loopholes. This isn’t about putting every such question beyond debate and deliberation, but it is about rejecting the notion that anything subtracted from revenue is a tax break, and that any tax exemption, no matter how structurally integral to the nature of the tax, is a giveaway.
Structure matters. The distinctions between different types of tax depends on that realization, as do the economic arguments for those different taxes. Productive policy conversations require affirming that each tax has a particular shape, and that flattening everything out into a tax on gross is not neutrality, but rather, gross distortion.
Obligatory Marketing Note
My new consultancy provides tax policy research, writing, and other services, both project-specific and on retainer (or in visiting fellow-style roles). If you are in the market for tax policy research or know someone who is, please let me know.
Please Share this Substack
If you find this Substack valuable, please do me a favor and share it with colleagues and others who may be interested. And if you haven’t yet subscribed (it’s free), please consider doing so!