Episode 41
Episode summary
Tax credits are a popular tool of policymakers to influence the behavior of people and businesses. But they don’t come without tradeoffs or cumbersome rules to follow. Caleb and Liz discuss.
Shownotes
Are Today’s Tax Credits the Best Way to Get Americans to Buy E.V.s? [NYT]
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Transcript
Liz Wilke (00:00:00) – Hi, I’m Liz Wilke.
Caleb Newquist (00:00:02) – I’m Caleb Newquist
Liz Wilke (00:00:04) – And this is the gustonomics podcast. In each episode we bring you a little bit of economics knowledge so you can be more informed, use the information in your business or work, or have something to drown out all those political ads.
Caleb Newquist (00:00:17) – Please remember to rate, review and subscribe to the show or share it with an economics curious friend. Anything you can do to spread the word about the podcast is greatly appreciated. Hello Liz,
Liz Wilke (00:00:31) – hello Caleb.
Caleb Newquist (00:00:33) – What’s going on in economics news, Liz? What’s the latest?
Liz Wilke (00:00:36) – Well, the latest and greatest in economics news is that there were two very important reports out since we last recorded. The first one was the employment situation, also known as the jobs report, where the Bureau of Labor Statistics- my favorite Bureau- reported that we gained overall 245,000 jobs in September, which was a very healthy gain and far above expectations, I think okay, and above the 12-month average of 203,000 jobs. So a very healthy report.
Caleb Newquist (00:01:07) – And did the unemployment rate change as a result of that?
Liz Wilke (00:01:12) – It did. The unemployment rate dropped, actually about five percent total from 4.3 percent to 4.1 percent in this report, and jobs were concentrated in a few sectors, one notably food and hospitality, which means people are getting out, they’re having a good time, they’re feeling pretty good, and then also the sort of usual culprits that we have talked about before: health care and social assistance, government jobs and a little bit of construction.
Caleb Newquist (00:01:39) – Okay, any notable revisions that we should know about. You can say no.
Liz Wilke (00:01:47) – Yes, actually, we in fact revisions in an unexpected direction. So July was revised upwards by fifty five thousand, from about ninety thousand to about a hundred and forty five thousand, and august was also revised upwards by seventeen thousand. So I actually think that’s really interesting balance to a bunch of the downward revisions that we’ve had in recent months.
Caleb Newquist (00:02:10) – Right, so all the worrying, or all the recent worrying or semi recent worrying, is all getting balanced out by these latest revisions and, as you have pointed out many times during the- during the, I guess, tenure of this podcast, which is you have to look at these things collectively. You can’t just look at one month and freak the hell out. You have to look at a bunch of different things and tell the story that way, or try to tell a story that way, versus just focusing on one set of data, one month’s data.
Liz Wilke (00:02:49) – That’s generally always my advice, unless you personally thrive on the drama of the moment.
Caleb Newquist (00:02:55) – So if you’re an economics reporter, yeah, you’re just jumping from month to month and you know reacting accordingly. Okay, also, there was a new inflation number out recently, correct, Liz?
Liz Wilke (00:03:12) – That’s right. The new inflation number came out two point four percent twelve month change.
Liz Wilke (00:03:17) – That’s good.
Liz Wilke (00:03:18) – So it is. It is good news. I will say that it is not as big a drop as the expectation was. Right, so it is. It’s good progress. We have not reversed progress. I would say that, if anything, progress might have slowed a little bit. We’ll know a little bit more when we get next month’s data.
Liz Wilke (00:03:35) – What I think the combined very strong jobs report and slightly slower progress on inflation data might do is that at the November FOMC meeting we might have a hold instead of a cut right, because jobs market is still doing pretty well and the Fed might sort of want to see a little more progress on inflation before they think about another rate cut.
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Caleb Newquist (00:04:31) – All right, liz Wilkie? The main topic for this episode is related to taxes. We recently passed a filing deadline, which is not really relevant for this episode, but it kind of like is. It’s in the ballpark. We’re talking about taxes. That’s what we’re talking about,
Liz Wilke (00:04:53) – Caleb, don’t keep me in suspense. What is the deadline that we just passed?
Caleb Newquist (00:04:57) – Oh, when this recording will be released, the deadline will be the October 15th filing deadline for individuals and partnerships. I believe, I don’t know, I’ve been out of the game too long, Liz. I can’t keep it. They changed them at one point, but it’s definitely the drop-dead date for individuals: the October 15th deadline.
Liz Wilke (00:05:19) – So for most people who operate on the April 15th deadline for tax filings, what is the October 15th filing deadline?
Caleb Newquist (00:05:27) – Oh, am I answering the questions in this episode?
Caleb Newquist (00:05:30) – That’s kind of fun. So the October 15th filing deadline is for folks who extended their time to file prior to or on April 15th.
Caleb Newquist (00:05:44) – So imagine that you are a stressed, stressed out, busy person and don’t think really about your tax returns very much, and then, all of a sudden, you wake up one day and look at the calendar and it’s April 15th and you haven’t talked to your accountant and you haven’t opened any of the mail that says “important tax document” on it, and what you have to do then is file an extension of time to file so that you are not penalized if you owe taxes if you, if you’re just getting a refund, it doesn’t really affect you, but I don’t want to get too bogged down on that stuff.
Caleb Newquist (00:06:17) – But, in other words, it just gives you six more months to file your tax return without, without worry. You can do it, anyone can do it.
Liz Wilke (00:06:28) – As a person who has been previously stressed out, but not actually busy, I have used this deadline extension on a number of occasions. It’s total. Some effect for me is essentially to transfer an extreme state of anxiety from April 15th to October 15th, later in the year.
Caleb Newquist (00:06:46) – Yeah, that’s true, yeah, but- and I too have used the extension of time to file, but usually- in some cases though, I’ve actually filed my return by May 15th, like it’s. So sometimes you just need that extra month, Liz, and sometimes you need the six extra months.
Caleb Newquist (00:07:06) – But anyway, today’s topic, Liz, is something very popular in the tax world, not only for, like practitioners, like accountants, but also, I would say it’s something that comes up in economics quite a bit, because policymakers like this thing that we’re going to talk about and that thing is tax credits. So, yeah, what’s that? What’s what’s that?
Caleb Newquist (00:07:32) – What’s that acronym where people whisper into the microphones:
Liz Wilke (00:07:36) – ASMR.
Caleb Newquist (00:07:37) – ASMR. What if we did the podcast. Anyway.
Liz Wilke (00:07:43) – We have got this podcast because we’re having way too much fun.
Caleb Newquist (00:07:46) – So so, Liz, I let’s- let’s just let’s start at the beginning. For those that don’t know what is a tax credit,
Liz Wilke (00:07:58) – Caleb, a tax credit is a mechanism of tax policy by which you can apply a certain amount of money against taxes that you owe. It is different from a tax deduction.
Caleb (00:08:13) – Right.
Liz Wilke (00:08:14) – When you have a tax deduction, you basically have income right, and you get to deduct a deduction against your income, which lowers the overall amount of taxes that you owe. Yeah, a tax credit doesn’t make your income smaller, it just gets directly applied to the taxes that you owe.
Liz Wilke (00:08:33) – So it’s actually better than a tax deduction, because it’s a dollar for dollar reduction in taxes, versus a dollar for dollar reduction in income gets you a less than a dollar for dollar reduction in taxes.
Caleb Newquist (00:08:46) – Right, so it’s an important distinction because it’s easy to confuse these two things, so
Liz Wilke (00:08:57) – Lots of people get confused.
Caleb Newquist (00:08:58) – Yeah, and so like, as an, I’ll just try to confirm my understanding. But let’s say you have one job and that’s all the money you make, and you make a hundred thousand dollars, but you also have you also contributed money to an IRA, because that is a tax deductible thing, and say you deduct it. Say you contributed five thousand dollars to that IRA tax rules.
Caleb Newquist (00:09:23) – Say you can use that 5,000 bucks to reduce the $100,000 gross pay that you received, so that you’re now we’re getting on 95 right, so that you’re only gonna pass, so you’re only gonna pay taxes on the 95,000 instead of the full 100,000. That is a deduction, whereas for a tax credit you know how much tax you owe. Say you owe ten thousand dollars in taxes and like, well, that sucks.
Caleb Newquist (00:09:50) – But if you have children, for example, the child tax credit will reduce that $10,000 by however many children you have, by- I don’t remember the number, is it like 3,000 per kid, something like that? But let’s say it’s 3,000 bucks and let’s say you have three kids and so you get nine thousand dollars in tax credit, barring any other. You know details, all things, all things the same. So your ten thousand dollar tax liability is now reduced by $9,000.. So you only owe $1,000..
Caleb Newquist (00:10:20) – So yes, Liz Wilke, tax credits are better than tax deductions, without a doubt. And they are also very popular, as I mentioned, in, for policymakers. So, and both for individuals and for businesses, right? I think, I don’t think we’ve mentioned that, that tax credits can be for people and they can be for businesses too. So like, for example, the research and development tax credit is a common tax credit for businesses to take, right?
Liz Wilke (00:10:55) – That’s right.
Caleb Newquist (00:10:56) – Yeah, and there’s others, but, so Liz, I’ll ask you a question. Why are tax credits such, why are tax credits so popular? I mean, maybe it’s obvious, but like, what makes them so, why is that something that is common in kind of the policymaking world? And then why does that end up in our lives?
Liz Wilke (00:11:20) – So policymakers really like tax credits because it’s a very clean, easy way to try and incentivize people to do the things that you would want them to do, right? So you want businesses to invest in innovation. And so you say, hey, for every dollar that you invest in innovation, we will reduce your tax burden by a dollar. That’s a very clean cut way to do that. And it’s pretty easy to write a tax credit into law.
Caleb Newquist (00:11:46) – Yep. Now, there are some downsides to tax credits, right?
Liz Wilke (00:11:51) – There are some downsides.
Caleb Newquist (00:11:53) – What are the downsides?
Liz Wilke (00:11:55) – Well, I think the, I mean, I’m not sure that it’s a downside per se, but it’s just a trade-off, right? So for every dollar that you don’t collect in tax from someone, you have to collect in tax from someone else, right? If you want to spend a certain amount of money, right? In order to keep the government functioning. So tax credits privilege the people that qualify for them. And they sort of on the flip side, right? Kind of put the relative burden of paying taxes, right? On people that don’t qualify for them. The other downside.
Liz Wilke (00:12:27) – So there are some other downsides of tax credits. One is, so let’s take the electric vehicle tax, for instance. One of the downsides is that you’re giving everybody a benefit and some of those people would have already done the thing that you wanted them to do.
Caleb Newquist (00:12:43) – Right.
Liz Wilke (00:12:43) – Right. Businesses for competitive reasons already have an incentive to invest in R & D, right? And so without the tax credit, some of them would have already invested at R & D. And it’s hard to know who will invest in R & D just sort of on their own and who won’t. But you’re basically paying for something that would have happened anyway, right? So it’s difficult.
Liz Wilke (00:13:04) – Or for the electric vehicle tax credit, there are some estimates that lots of people who are buying electric vehicles basically would have bought an electric vehicle anyway without the tax credit. And so that can make things really efficient because you’re basically paying a lot more for the outcome you want than you really needed to because lots of people take advantage of tax credits because everybody that does the behavior gets the tax credit. You don’t just get it if you otherwise wouldn’t do it. You get it if you do it. So that can make tax credits very inefficient.
Caleb Newquist (00:13:36) – Right. And bonus downside that I’ll just mention is it makes tax compliance sometimes far more difficult. Right?
Liz Wilke (00:13:48) – Yep.
Caleb Newquist (00:13:49) – Yeah.
Liz Wilke (00:13:51) – They also only happen once a year, right? So if you’re a business per se and you pay quarterly taxes, right? On the estimate. So businesses generally pay quarterly taxes. They sort of estimate how much they’ll owe over the course of the year and they make quarterly payments to that. But they only get the tax credit back once a year. Right, Caleb?
Caleb Newquist (00:14:13) – Right.
Liz Wilke (00:14:13) – And so if you’re a business and you wanna manage your cashflow, right? You’re basically paying more over the quarter and then just once a year, you sort of get back your tax credit all at once. Right? And that can, it’s difficult to what you might call consumption smooth. Right? Or smooth out your cashflow if you’re an individual or a business. And so it would be easier if you could get a tax credit back, right? Every quarter or every month that you’re an individual. And the other difficulty of tax credits is documentation. Right?
Liz Wilke (00:14:43) – So if you claim a tax credit, you have to prove that you did the thing that qualifies you for the tax credit.
Caleb Newquist (00:14:51) – Ah, yes.
Liz Wilke (00:14:52) – And that can be very easy. Like I show a receipt for the electric vehicle that I bought or it can be very hard. So for instance, in the case of the R&D tax credit, you might have to show, I paid an engineer, you know, $120,000 a year. They spent 36% of their time on, you know, what would qualify as an R&D activity.
Caleb Newquist (00:15:16) – Right.
Liz Wilke (00:15:16) – And then I also bought some lab equipment, but, you know, only 50% of that was used for R&D activities. So the accounting for these tax credits can be pretty cumbersome, especially if you’re a small business, right? Or a single individual. Because the rules can get pretty complex.
Caleb Newquist (00:15:31) – Right. Right. Okay. So with all that in mind, Liz, I’ll try to ask this as simply as possible. And I know it’s going to be a complex answer, so.
Liz Wilke (00:15:43) – Because it always is. Because it always is.
Caleb Newquist (00:15:46) – Do tax credits work? Do they have the intended effect?
Liz Wilke (00:15:50) – The shortest answer I’m going to give is yes.
Liz Wilke (00:15:56) – But.
Liz Wilke (00:15:56) – That’s my official answer, yes but. And back to what I had previously said, yes but is inefficient a lot of the time, right? Because you get the outcome, right? So if you give an R&D tax credit or you give a homebuyer’s tax credit, you incentivize people to buy homes and to invest in R&D or to buy electric vehicles. You definitely get that outcome. But you might pay a lot for it, right? And so yes, you get the outcome. Yes, they do work, but they might not be very efficient mechanisms, right, to get the outcome that you want.
Liz Wilke (00:16:34) – The other possibility is that tax credits sort of just cancel out or they get priced in. So for example, there’s a policy proposal that we should give homebuyers a tax credit for purchasing a home in the hopes that that will make home ownership much more affordable, right, for lots of Americans, which is a very laudable policy goal. There is an open question. So if I give every homebuyer $20,000, basically, in tax credits to buy a home, there’s a very open question about whether or not that will just raise the price of a home by $20,000, more or less.
Liz Wilke (00:17:13) – And I don’t think we know exactly what the dynamics of that are. I certainly don’t know exactly what the dynamics will be there. But a lot of economists have said, well, if you just give everybody $20,000 extra to buy a home, you’ll just raise the cost of a home by $20,000 extra. And it might not be $20,000 exactly. It might be $15,000 or $10,000.
Liz Wilke (00:17:32) – But by sort of making tax credits available to everybody to purchase things like electric vehicles or homes, you kind of push the price up because, again, everybody is entitled to a tax credit that does the thing. So there are these sort of market effects. So I think the overall answer is, yes, tax credits do get the behavior that you want, but not sort of as cleanly as you would like oftentimes.
Caleb Newquist (00:17:56) – OK. So tax credits are used a lot. And so maybe the answer to this question is obvious. But why do small businesses, why should small businesses care about tax credits?
Liz Wilke (00:18:12) – One.
Caleb Newquist (00:18:14) – Because they can get them, right? They can qualify for them.
Liz Wilke (00:18:17) – Yeah, I mean, I think the first thing is small businesses don’t really need to worry about the efficiency of tax credits, right? The tax credits exist. It’s a question for policymakers and government wonkity wonks to figure out if tax credits are efficient or not and how else to increase behaviors that we want to see. If you are a small business, congratulations. There are many tax credits for you that are intended to encourage you to do things, right, or to make life easier for being a small business.
Liz Wilke (00:18:45) – So for example, we’ve talked about the R&D tax credit, which is definitely a credit that small businesses can take. It’s not just for large businesses. There are tax credits that are temporary. So during COVID, we had the employee retention tax credit, where if you kept employees on, you got a tax credit back for some or all of their income. But there are also tax credits for you for providing and contributing to a 401k or retirement plan for your employees. There are tax credits for tuition repayment or training for your employees.
Liz Wilke (00:19:20) – There are tax credits for hiring people that have difficulty finding work traditionally. So that’s all to say that as we approach the end of year tax season for many businesses, where they are reconciling their books and really trying to do this, this can be a really significant difference for small businesses in their bottom line overall.
Liz Wilke (00:19:41) – And spending even just a little bit of time finding out what tax credits apply to you, talking to your accountant, and then figuring out in advance what documentation you might need to show in order to get them can make a really, really sizable difference in the P&L for your company this year. These tax credits are not necessarily small. They could be tens of thousands of dollars. They could be multiple tens of thousands of dollars. And they could also add up. So I would just say for small businesses, great.
Liz Wilke (00:20:13) – Don’t worry about the efficiency implications of tax credits unless you’re really into that sort of thing. And find out what tax credits apply to you.
Caleb Newquist (00:20:23) – Great. That’s it for this episode. We hope you learned something new and useful for yourself or your business. Please let us know what you think of the podcast by leaving a review. And still share this podcast with a friend or colleague who might enjoy it. OK? All right. I’m Caleb Newquist.
Liz Wilke (00:20:40) – And I’m Liz Wilke. Thanks for listening.
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