Tax statement. Flickr

Whenever the Twitter horde sets its sights on taxes or the budget, a stunning amount of mis­in­for­mation follows. People have little or no under­standing of terms many econ­o­mists and politi­cians throw around con­stantly and this became increas­ingly apparent during my dis­cus­sions with others on Twitter regarding the tax exemption for col­leges who do not receive federal funding, such as Hillsdale.

Behind all the rhetoric was the basic mis­con­ception that somehow a tax exemption is the same thing as a “handout.” Anyone who under­stands basic public policy knows this is false. Those who mis­un­der­stand equate not taking money (tax exemption) from an entity to giving that entity tax­payer money (sub­sidies, handouts, ear­marks, grants, etc.).  

Imagine two sce­narios: one in which your company is tax exempt and another in which your company pays a 25 percent tax rate on your profits but then receive a subsidy equal to the amount you were taxed.  If your company makes $1 million in profits, then many people’s under­standing would say that in both sce­narios yield the same result.  

Though the company tech­ni­cally receives all $1 million in both sce­narios, the second has hidden costs for both the company and the gov­ernment. The company must cal­culate all its taxes in the second sce­nario, making the company either divert some of its current workers or employ new workers in order to comply with the tax­ation, increasing costs. The IRS then must process the taxes and do its own cal­cu­la­tions to ensure your company is com­plying with the 25 percent tax rate.  Another agency then must process the subsidy back to your company.  

This bureau­cratic round­about process causes unnec­essary costs for both the company and the gov­ernment. This sce­nario is not unre­al­istic. Col­leges that receive federal funding undergo a very similar sit­u­ation with the imple­men­tation of the college endowment tax; they pay money to the gov­ernment just to get money back. Col­leges that don’t receive federal funding instead just pay taxes then and receive nothing back. This incen­tivizes col­leges and com­panies to lobby for federal money because they going to get taxed anyway.

Often, tax exemp­tions often protect estab­lished interests and lob­byists. All of these policies are inter­ven­tions and distort the market, even if tax exemp­tions are more effi­cient than sub­sidies.  Know the dif­ference between the policies, but also know that the same power to grant an exemption or subsidy to your favored group grants the gov­ernment to choose who wins and who loses. 

If we want a thriving economy, the answer is not for the gov­ernment to pick its favorites, granting special priv­i­leges, exemp­tions, and sub­sidies to com­panies who agree to hire more workers, build a factory in an area, etc. Instead, we must reduce taxes for all and cut reg­u­la­tions while we’re at it. Let con­sumers pick who wins and who loses.  

When com­panies must cater to the con­sumer and not the gov­ernment, the lob­byists will no longer control our economy.  Tax exemp­tions must not be con­fused with handouts and sub­sidies, but they also must not be con­fused with the power of the market process.