Tax Breaks, Loopholes, and Outright Fraud

I was talking to a friend of mine lately, someone who is not a big fan of government, and his opinion on tax breaks and loopholes was this:

“Taxation is a way of raising money for the services we need.” I don’t think anyone will disagree with that. Well, anyone except anarcho-capitalists, the most rampant free enterprisers in the United States, who believe that anything people need can be provided by the business world, including education and health care.

However, my friend went on to state, “Taxation should not be a way to manipulate the economy.” Now, that’s a rather broad statement, and taken out of the context of the conversation, but is it true? Besides legislation, control of taxes is the most powerful tool governments have to persuade businesses and individuals to act in ways that are beneficial to the common good.

And There’s the Rub

The problem is in deciding what ways turn out to be truly beneficial. Let’s take the actions of various governments to Bombardier over the past years. Andrew Coyne’s latest gallop on this, one of his favourite hobby-horses, makes it quite clear that there has been an evolutionary change in the attitude of both provincial and federal governments towards Canada’s favourite (and only) aerospace company. It used to be a matter of whether the money would be spent for the good of the population. Now, for Quebec, any move towards letting one of their biggest employers face the consequences of its own actions is a swipe at provincial autonomy. For the federal government, an attack on their baby is an attack on Canada itself.

Andrew Coyne Looks Deeper

And you can’t help but be swayed by Coyne’s arguments in this and other posts. Once the government starts supporting a business, the business tends to depend on that support, weakening its performance and competitiveness against the rest of the world. An instance would be the lean, efficient Canadian forest companies, which out-perform their sheltered American counterparts, grown slack because of protectionism. It sounds like, when it comes to failing companies, tough love should be the order of the day.

These examples show on a wide scale the downside of government support. When we give tax breaks to a company to relocate to our town or province, the populace is, in a roundabout way, paying tax money from all of us to support a few of our workers. Also, we have set up the workers in that industry as hostages to ensure continued support for the employing company. Right-wing governments whose reputation rests on their job creation results find themselves in the difficult position of espousing socialist actions to achieve their goals.

But do the highly publicized failures we see in the media mean a complete negation of all use of taxes for managerial uses? For example, a municipality charges less tax on businesses locating in certain areas because they want to concentrate business in those areas. Is there anything wrong with that? We have decided that charity is good for the country. So charitable donations get tax breaks. Are you going to trash that idea? Governments provide infrastructure (roads, electricity, water) to spur development. Where do we draw the line?

It’s Not What They Do, but Why

The problem is not what actions governments take in this respect, but why. Politicians have long had the reputation, in some cases well deserved, for using the public purse for political or personal gain. Media love to tout statistics showing the unbalance of infrastructure payouts to ridings that elected government representatives. There is a great uproar in Quebec right now because a former mayor of Montreal has been convicted of taking kickbacks from companies that wanted contracts with the city.

Levels of Damage

It might be handy to divide the different uses of tax dollars by their relative use to the average citizen.

  1. Illegal: where the money comes directly to the public official in the form of bribes and kickbacks.
  2. Mostly illegal: where conflict of interest puts the tax dollars and breaks towards friends, associates, and political allies of the public official
  3. Mostly legal but should it be: where public officials bend the rules so their constituents and supporters benefit more than the rest of the country
  4. Legal but stupid: where harmful or wasteful decisions are made for political, ideological, or bureaucratic reasons. There are probably a whole lot more of these than the public ever hears about.
  5. Legal and useful: tax money spent or uncollected to influence reasonable, useful changes in society.

How to Make It Work?

The difficulty is separating the illegal from the legal, the properly motivated from the fraudulent, and finally, the useful from the harmful. The inability of governments and bureaucrats to make successful choices was the downfall of most of the Communist states in the 20th century. Surely there were a few well-meaning souls in the USSR who believed in Communism and wanted to make it work. They couldn’t. The Department of Indian Affairs in Canada seems to be a continued thorn in the side of every government since I don’t know when. Throwing good money after bad seems to be an epidemic.

Don’t Chuck the Baby With the Bath Water.

My friend’s contention is that if we were to close all the tax loopholes and incentives to special interest groups, we could lower taxes for everyone else and still have the same amount of government revenue. Another idea that’s hard to argue against.

But that doesn’t mean we have to trash the system completely. It seems to me that at a simple level, a certain amount of fiscal leverage is a useful tool for government to use to fine-tune the economy. The difficulty is in knowing when to draw the line: to decide when the interference is too great and/or likely to have adverse effects. Given the propensity for politicians to want to keep playing politics, I don’t see much willingness to make any changes in the near future.

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