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A Reminder About Tax Neutrality

With the election less than a week away, both presidential candidates have been making a lot of tax promises to specific voting groups that they are trying to attract. 

Donald Trump has promised to eliminate taxes on tips, taxes on Social Security benefits, and even to undo part of his own 2017 tax reform—the SALT cap, which limited the federal tax subsidy for high-tax states. 

Meanwhile, Kamala Harris is promising special tax breaks and tax subsidies for families with children, first time home buyers, and even for black men starting businesses. 

Trump’s promise to eliminate taxes on tips came while he was campaigning in the swing state of Nevada, where tipped employees are populous. Harris’ promised subsidies to black men came a week after reports that she was polling poorly with . . . black men. 

Seems like the principle of tax neutrality has been tossed overboard. So let's talk about it. 

Tax neutrality is a key principle of tax reform that was at the forefront of the Reagan tax policy in the 1980s, and that continued through the 1990s and the 2000s. Tax neutrality means that the tax code should not be used to reward or punish any specific behaviors, but rather should be neutral toward household and business decisions. 

In other words, the tax code should not encourage or discourage individuals from buying a home, from going to college, from having children, from marrying, and it should not reward or punish businesses for whether they choose to purchase equipment or lease equipment, etc. 

The core philosophical idea behind tax neutrality is that in a free economy, it is not the government’s job to direct you to behave in a way that it prefers. You should be able to run your household, and run your business, based on your own criteria, and not based on the details of the tax code. 

Furthermore, government does NOT know best. If the tax code is used to influence household and business decisions, it might be influencing those decisions in the wrong way. And that wrong way might have serious unintended consequences for innovation and economic growth. 

Essentially, tax policy should raise the necessary revenue for government while introducing as few distortions as possible. It will never be perfectly neutral—the home mortgage interest deduction for instance creates a pro-housing distortion—but it should be as neutral as possible. And that means politicians should not use the tax code to buy votes or to reward favored constituencies. 

But that would require candidates who operate from principle, and sadly that’s out of fashion in 2024 America.