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April 4, 2012
If Mandate Is Struck Down, Are Tax Incentives Next?

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By Martin A. Sullivan --

For lawyers and political junkies, it is the Super Bowl: three days of Supreme Court arguments over one of the biggest domestic policy changes in decades.

But we economists can only scratch our heads. Why are we in court? What's the big deal? It's called an "individual mandate." Sounds ominous. But to economists it looks like nothing more than your everyday ordinary tax incentive. For as long as there has been a tax code -- and particularly in recent decades -- there has been a bipartisan consensus that tax incentives are an excellent way for Congress to get individuals and businesses to do what lawmakers want them to do.

The only difference between the mandate and your common tax incentive is that Congress framed the incentive as a tax penalty instead of a tax break. I recognize there might be a legal difference between the two approaches that is beyond my comprehension. But the Court, Congress, and the public should understand that economically the two approaches are exactly the same. Any tax penalty can easily be redesigned as a tax incentive. So, for example, a $1,000 tax penalty for not doing X could be replaced by a tax policy whereby all individuals' taxes are raised by $1,000 and then they are given a tax credit of $1,000 for doing X. (See the table below.)

A tax penalty and a tax incentive have the same economic impact on affected and unaffected individuals. They have the same effect on the goals the government is trying to achieve. They have the same effect on government revenues. It is possible, then, that they have the same effect on freedom and constitutional principles.

So armchair constitutional scholars should enjoy the show. But please excuse us economists if we tune out. Perhaps too blithely, we assume the mandate will be affirmed because the nation's leading legal gurus won't want to open up a can of worms that makes all tax incentives subject to constitutional challenge. If by chance the court does strike down the mandate, by all means give us a call. It could be the beginning of the end for all those complex and inefficient tax incentives we have been complaining about all these years.

     What's the Difference Between the `Mandate' and Other Tax Incentives?

                        Individual Mandate         Standard Incentive
 Basic Policy           Under Healthcare           Provided Through
 Approach               Reform Act                 Tax Expenditures

 Simple example         $1,000 penalty for not     $1,000 tax increase with
                        having health insurance    $1,000 tax credit for
                                                   having health insurance

                          Part 1. Equivalent Economics
                    -- No discernible economic difference --

 Tax effect on          $0                         $0
 individual with
 health insurance

 Tax effect on          +$1,000                    +$1,000
 without health

 Government             +$1,000                    +$1,000
 revenue effect

 Incentive effect       +$1,000 to purchase        +$1,000 to purchase
                        insurance                  insurance

             Part 2. Equivalent Moral and Constitutional Arguments
      -- If true for one approach, it should also be true for the other --

 Effect on personal     Government is infringing   Government is infringing
 freedom                on individual rights.      on individual rights.

 Effect on economic     Government should not      Government should not
 freedom                require purchase under     require purchase under
                        threat of economic         threat of economic
                        penalty.                   penalty.

 Threat to contract     Contract with insurance    Contract with insurance
 law                    company is not valid       company is not valid
                        given duress caused        given duress caused
                        by incentive.              by incentive.

 Violation of           There must be limits on    There must be limits on
 commerce clause        Congress's ability to      Congress's ability to
                        intervene in markets.      intervene in markets.

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