Reforming Tax Incentives Into Uniform Refundable Tax Credits

Abstract

Each year the US federal individual income tax delivers over $500 billion worth of tax incentives intended to encourage socially beneficial activities. Currently the vast majority operate through deductions or exclusions, which link the size of the subsidy to the taxpayer's marginal tax bracket. This article argues that uniform refundable credits are a more efficient approach for tax incentives intended to correct for positive externalities, absent evidence that positive externalities exist or that externalities or elasticities associated with the subsidized activity vary by income class. Moreover, some type of refundable credit should almost always be the most efficient subsidy even if externalities or elasticities rise with income. Their efficiency benefits are further magnified by their tendency to automatically smooth household income and macroeconomic demand. This article thus proposes a dramatic change in how the government provides tax incentives for socially valued activities: the default for all such tax incentives should be a uniform refundable tax credit.