Latest / The Fiscal Policy Podcast with Fexingo: Government Budgets, Stimulus, and Public Spending / How Tax Credits Shape Your Daily Spending Habits
Transcript
- Lucas: Let’s start with a number that usually surprises people when they hear it for the first time. The United States spends roughly two hundred billion dollars annually on tax expenditures, which is basically the government choosing not to collect revenue rather than spending it directly. That is about three times what we spend on national defense, yet you rarely see a headline about it because no check is actually written. Luna: Right, it’s invisible money. So when we talk about stimulus or budget cuts, we’re mostly talking about visible spending while ignoring this massive shadow ledger. Lucas: Exactly. And today, I want to drill into one specific area where this invisibility causes real friction: the clean vehicle tax credit. It was designed to accelerate the transition to electric vehicles, but the way it’s structured has created a bizarre disconnect between policy goals and actual consumer behavior. We are seeing millions in unclaimed credits every year, even as automakers struggle to move inventory. Luna: That sounds counterintuitive. If the goal is adoption, why would people leave money on the table? Is it just that they don’t know it exists? Lucas: It’s deeper than awareness. The credit is non-refundable, which means you can only use it if you already owe enough in federal income taxes to offset it. If you buy an electric car but your tax liability is zero or very low, you get nothing. You can’t take a refund for the difference. So, by design, the biggest beneficiaries are middle to upper income earners who have high tax bills, while lower-income buyers—the exact demographic many policymakers hope to reach—are locked out. Luna: So it acts more like a subsidy for wealthy drivers than a tool for mass adoption. Does the data show that shift in demographics? Lucas: The Treasury Department’s own data confirms it. In the last quarter leading up to October twelfth, twenty twenty six, nearly seventy percent of the clean vehicle credits went to households earning over one hundred thousand dollars. Meanwhile, less than five percent went to those under fifty thousand. It’s a classic case of a well-intentioned policy failing because it doesn’t match the financial reality of the target audience. Luna: And those lower-income buyers are often the ones most sensitive to upfront price changes, so missing them entirely undermines the whole environmental argument. Lucas: Precisely. And here is where it gets complicated for the dealerships. They are supposed to offer an immediate point of sale discount instead of waiting until tax season, but most small dealers simply don’t participate. Why? Because the paperwork and compliance burden is too high for the margin they make on the sale. So you end up with a system where the credit exists on paper, but for most consumers, it’s effectively theoretical. Luna: It feels like we’re building a bureaucracy around a problem that could be solved with a simpler mechanism. Have economists debated swapping this for direct cash grants? Lucas: They have, and it’s been a fierce debate. Some researchers argue that a direct rebate—say, five thousand dollars handed to the buyer regardless of tax status—would be far more efficient. It removes the friction of tax filing, it reaches more people, and it actually moves units off the lot faster. But politically, it’s harder to sell because it looks like 'free money' rather than an incentive tied to responsible behavior. Luna: But isn’t that just semantics? If the outcome is more electric cars sold, does it matter if it’s called a grant or a credit? Lucas: For the economist, yes. For the politician, no. There is a strong preference among lawmakers for using the tax code as a lever because it allows them to claim they are incentivizing private sector innovation without appearing to hand out welfare. It’s a narrative choice, not necessarily a practical one. And that narrative choice has consequences for how the market adapts. Luna: I wonder if that narrative pressure is also why we see so many complex eligibility rules, like battery sourcing requirements or domestic assembly mandates. Lucas: Spot on. Those rules weren’t there in the original legislation. They were added later to satisfy trade concerns and protect domestic manufacturing jobs. But each new rule adds another layer of complexity, making it even harder for small dealers to administer the credit. It turns a simple purchase into a mini-compliance audit. Luna: So the policy becomes self-defeating. The more controls you add to ensure it serves broader goals, the less effective it becomes at its primary goal. Lucas: That is a fair critique. And it’s not just limited to electric vehicles. Look at the residential solar credit. It’s been around for years, and it has successfully boosted installation, but again, it disproportionately benefits homeowners who can itemize deductions and have sufficient tax liability. Renters, who make up nearly half of urban households, get absolutely nothing from it. Luna: Which seems like a huge gap in climate policy if you’re trying to decarbonize cities. Renters can’t install panels on roofs they don’t own. Lucas: Right. And landlords have little incentive to invest in efficiency upgrades if they aren’t the ones paying the utility bill. This is known as the split-incentive problem, and tax credits do almost nothing to solve it. We’ve essentially built a fiscal architecture that favors asset owners over everyone else. Luna: It makes me think about the broader trend of using tax breaks to solve social problems. We do it with childcare, with home buying, with healthcare. Is there a pattern here? Lucas: There is. The pattern is that tax expenditures tend to reinforce existing wealth structures. If you have assets, you benefit from deductions and credits. If you don’t, you bypass the system entirely. It’s regressive by design, even when the intent is progressive. And because these are buried in the tax code, they escape the usual scrutiny that direct appropriations face in Congress. Luna: So they become permanent features of the budget, hard to remove because once you’re used to a deduction, taking it away feels like a tax hike. Lucas: Exactly. It’s political suicide to remove a popular tax break, even if economists agree it’s inefficient. So we accumulate these layers of exceptions, loopholes, and special treatments until the tax code becomes a labyrinth. And the cost of navigating that labyrinth falls on taxpayers and small businesses alike. Luna: Does that mean we should be skeptical of any new fiscal proposal that relies heavily on tax incentives? Like the recent housing affordability initiatives? Lucas: I’d say we should scrutinize them much more closely. Take the mortgage interest deduction. It’s one of the largest tax expenditures in the country, totaling over eighty billion dollars a year. But it primarily benefits high-cost markets and high-income borrowers. A family in a rural area with a modest mortgage gets a tiny benefit compared to someone in San Francisco or New York. It drives up home prices by subsidizing demand without increasing supply. Luna: So it contributes to the very crisis it’s supposed to help solve. That’s a really sharp insight. Are there any examples where tax credits actually worked as intended? Lucas: Research and development credits are a decent example. They’ve helped spur innovation in pharmaceuticals and tech, though even there, the benefits skew toward large corporations with sophisticated tax departments. But the key difference is that R&D credits don’t require you to be wealthy to access them; they’re tied to activity, not status. That’s a model worth studying. Luna: Activity-based versus status-based. That’s a useful distinction. It shifts the focus from who you are to what you do. Lucas: Exactly. And it highlights why refundable credits are gaining traction among policy experts. If you make the credit refundable, it becomes a true transfer payment that works for everyone, regardless of their tax bracket. It’s simpler, fairer, and often cheaper to administer because you eliminate the need for complex matching algorithms. Luna: But wouldn’t that blow a hole in the deficit? Refundable credits cost more money than non-refundable ones because you’re paying out money you didn’t collect. Lucas: That’s the accounting illusion. Whether you give someone a credit or send them a check, the cost to the treasury is the same. The only difference is how it’s labeled. Calling it a credit makes it feel less like spending, even though it functions identically. It’s all semantics. Luna: Semantics that shape our entire political discourse around taxation. It’s wild how much power language holds in public finance. Lucas: It really is. And as we look ahead to the next fiscal year, the pressure to expand these credits will grow. Everyone wants a piece of the pie, and the tax code is the easiest place to hide the cost. But I think listeners should start asking: who actually gets this money, and is it achieving the stated goal? Luna: Because if the answer is just 'wealthy people,' then maybe it’s not a policy failure, but a feature of the system we need to confront. Lucas: Or at least understand. Because ignoring it doesn’t make it go away. It just means we’re operating blind when it comes to how our economy actually works. Luna: If walking through the economy with us has made something click, we deliberately don't run ads on these shows. If you want to support that choice, the link is buy me a coffee dot com slash fexingo. Lucas: It keeps the lights on without selling your attention to the highest bidder. And that matters when we’re discussing topics like tax policy, where incentives are everything. Luna: Thanks for keeping this independent. Now, back to the numbers. Lucas: One final thought before we wrap up. When you look at the upcoming budget proposals, pay attention to the line items labeled 'tax expenditures.' They are often the quiet drivers of inequality, shaping your daily spending habits in ways you never notice. The question isn’t just whether we can afford them, but who they are really for.