It is possible to spend $100,000 on a luxury car. Most people don’t, and not just because they can’t ‘afford’ one. Even among Americans with more than $100,000 in wealth, only a small share would choose to spend $100,000 on a luxury car.
You can also spend $35,000 on a luxury car, something like a Toyota Camry. You might object that a Camry is not a luxury car. Actually it is. Automakers have essentially perfected the art of building a high-quality car. These days, the difference in quality between something like a Camry and a $100,000 car is so small that it’s hardly worth commenting on.
What would make me buy a $100,000 car? Maybe if the government paid 95% of the cost of my new car. In that case, I might rather spend $5,000 (out of pocket) on a nice Mercedes than $1,750 on a new Camry.
It would be extremely wasteful if price distortions caused our economy to switch from producing $35,000 cars to producing $100,000 cars. However, we have done something similar in other sectors – thanks to subsidies.
What would make me spend $100,000 on a medical procedure instead of $35,000 on an almost as good procedure? Subsidies. If I had to pay just a small percentage of the costs myself, the highest quality procedure would become much more attractive. That’s one of the reasons why America spends 17% of its GDP on medical care.
This Bloomberg story I noticed:
Trump’s economic advisers are considering doubling the state and local tax deduction, a popular — but expensive — tax break that could provide big savings for many residents of New York, New Jersey and California.
Economist Stephen Moore, a member of President-elect Donald Trump’s economic advisory transition team, told Bloomberg on Thursday that the group has discussed expanding the tax write-off limit from $10,000 to $20,000.
In my opinion, the decision to cap the SALT deduction at $10,000 was the most successful economic policy initiative of the past decade. It had two main advantages:
1. The deduction has greatly simplified tax preparation for many taxpayers (myself included). Now you can simply take the standard deduction, avoiding a lot of time-consuming paperwork.
2. The SALT cap took away a major subsidy for spending at the state government level. For people in the 40% federal tax bracket, the SALT deduction meant that the federal government effectively paid 40% of their state tax bill, at least in those states that have an income tax. In the period since the change, a number of states have started lowering their income tax rates, which is exactly what I expected. If the limit increases to $20,000, states will have a strong incentive to incur additional wasteful spending.
P.S. Of course, the claim of “the most successful economic policy of the past decade” is a very low bar, as the past decade has been one of almost unrelenting policy mistakes.