“Every Incentive is a Disincentive” by John Edward

John Edward teaches economics at Bentley and UMass Lowell. He’s a frequent contributor of columns on economic issues. Here is his latest:

Forgive me for noting that conservatives seem to believe that the rich will work harder if we give them more, and the poor will work harder if we give them less.
                                                                            – E.J. Dionne Jr.

Economics is called the science of incentives. Policymakers need to know that every time they try to encourage one behavior, they run the risk of discouraging some other behavior.

The incentive behind a lower tax rate on capital gains is to encourage investment and prudent risk taking. Why should people who work for a living pay higher rates on their earned income? By attempting to encourage investment, policymakers are discouraging work and driving us closer to The Social Cliff of excessive inequality.

The maximum tax rate on long-term capital gains is 20 percent. The maximum rate on earned income is twice as high. By taxing capital gains at a much lower rate, the federal government gave away $161 billion in potential tax revenue in 2013.

In addition, policy makers are encouraging those who can get away with it to shift their income from “wages” to “gains.” Hedge fund managers spend a lot of money lobbying to make sure the government taxes “carried interest” as capital gains, even though they earn the money on someone else’s investment, and the manager is not assuming risk.

The incentive behind lower property taxes for corporations is to get them to move into town. Local politicians offer tax concessions to lure businesses. The tax breaks get a lot of publicity, but they are not very effective. By giving businesses lower taxes, property taxes for residents go up, forcing some of them to move out of town.

When I moved to Chelmsford in 1990, corporations paid 28 percent of the tax levy. Now they pay 19 percent. Communities that compete for businesses by offering tax incentives are creating a disincentive for people to live in the community.

The incentive behind mortgage and property tax deductions is to promote home ownership. The federal government gives away hundreds of billions of dollars every year to homeowners via tax breaks.

These incentives encourage people to buy homes, even when the home they are buying is beyond their means. They serve as a disincentive for people to pursue more affordable rental options. Worse yet, home ownership incentives divert money that could promote truly affordable rental units during, what Secretary of Housing and Urban Development Shaun Donovan called in a speech, “the worst rental affordability crisis that this country has ever known.”

The incentive behind the individual mandate of the Affordable Care Act is to expand health insurance coverage. This is a case where the government is finally getting the incentives right.

Some resent the government forcing them to get insurance. No one is being forced. Everyone has health insurance. Unfortunately, for many, it is called the emergency room.

Health insurance coverage is expensive. The high cost is a disincentive for people who do not think they will need the coverage. Many young people, believing they are healthy, do not pay for insurance. The health insurance pool is over weighted with unhealthy people. That is one reason why insurance is so expensive. In addition, when the people who think they are healthy are wrong, we all pay for their lack of coverage.

That is why former Governor Romney included an individual mandate in the Massachusetts health care reform law. It makes sense nationally as well.

When the President signed the Affordable Care Act, 50 million people were uninsured. More than 8 million have signed up for private health insurance under the program. Many who signed up are young. The Congressional Budget Office estimates that by 2016 the Affordable Care Act will cut the number of uninsured in half. The individual mandate and improved affordability are providing the right incentives.

The incentive behind the Earned Income Tax Credit (EITC) is to promote work. The EITC is another example of government getting the incentives right.

The debate over the minimum wage has raised awareness about the plight of low-wage workers. The President’s proposal to expand the EITC is getting much less attention. The EITC encourages people to earn a living wage. You only get the credit if you earn income – if you have a job.

The President’s proposal is to increase the credit available to households without children, which is currently minimal. Given that there is a separate tax credit explicitly for the cost of raising children, an expansion is both fair, and necessary.

Even better, the President wants to pay for the expansion of EITC by closing tax loopholes. The incentive of many of these tax loopholes is to devise clever accounting schemes rather than to promote investment.

The incentive of financial aid is to make college more affordable. The unintended consequence is to make college more expensive.

Financial aid is an incentive for colleges to increase tuition. Thirty years ago the average annual cost for a 4-year college, including room and board, was 16 percent of median income. Now it is 38 percent.

As outlined by President Obama’s plan to make college more affordable the government should tie financial aid to progress by Colleges and Universities on restraining tuition increases. We should also consider vouchers as an alternative to financial aid based on cost. There must be incentives that force Colleges to compete for students based on the quality of education, the return on investment, and price.

Let your elected officials know there is a price to pay every time they try to influence our behavior via incentives.