CHANNELLING Behavior : Rewards and Punishments through the Tax System

In the 1960’s, an infamous memo from the Draft (Selective Service System) described “manpower channelling” as an important part of the draft. Using draft deferments, the system could “channel” young men to behave in ways that were seen as “in the national interest”. Quoting from the memo:

In the Selective Service System, the term “deferment” has been used millions of times to describe the method and means used to attract to the kind of service considered to be the most important, the individuals who were not compelled to do it. The club of induction has been used to drive out of areas considered to be less important to the areas of greater importance in which deferments were given, the individuals who did not or could not participate in activities which were considered essential to the Nation.

… It is in dealing with the other millions of registrants that the System is heavily occupied, developing more effective human beings in the national interest.

In short, the draft “channelled” young men to make choices they might not have otherwise made, punishing bad choices with induction into the military and rewarding good choices with deferments from military obligations. The most well-known “good choice” was college – the memo boasted:

Many young men would not have pursued a higher education if there had not been a program of student deferment. Many young scientists, engineers, tool and die makers, and other possessors of scarce skills would not remain in their jobs in the defense effort if it were not for a program of occupational deferments. Even though the salary of a teacher has historically been meager, many young men remain in that job, seeking the reward of a deferment. The process of channeling manpower by deferment is entitled to much credit for the large number of graduate students in technical fields and for the fact that there is not a greater shortage of teachers, engineers and other scientists working in activities which are essential to the national interest.

The Selective Service System was not the only way in which our government “channelled” people to make “good” choices and avoid “bad” choices. When you look at our tax code, you find the same kind of system of rewards and punishments based on how you choose to make or use your money.

6355404323_cf97f9c58e_zWe have a long history of so-called “sin taxes” – taxes levied on products that are legal to us but frowned upon by some influential segment of society. Alcoholic beverages are taxed. Cigarettes are taxed. Marijuana, where legal, is taxed, and more states are looking enviously at Colorado’s experience raising tax dollars from the legal sale of marijuana. And thee was quite an uproar when some states and cities tried to create a tax on sweetened, carbonated soft drinks – the “soda tax”.

All of these taxes are examples of how the tax code is used to discourage behavior that is frowned upon but not illegal.

The tax code is also used to reward behaviors that are deemed “good” – but this is not as obvious as the sin taxes are. A well-known example is the home mortgage interest deduction – this is a reward given to someone for taking out a mortgage to buy a home rather than paying a monthly rent. Home ownership is believed to be good behavior and in the national interest; thus, a home owner is rewarded with a tax deduction.

It was once the case that a taxpayer got a deduction for other kinds of interest payments – credit cards, auto loans and so forth. But those have been removed from the tax code. Apparently, it is “good” to pay interest on a home loan, but “bad” to pay interest on a credit card or an auto loan.

Likewise, tax rates are different on income, based on how that income is obtained. If you are an employee, earning a wage or a salary, your tax rate may be as much as 39.5%. However, if you make the same amount of income from investments and dividends, your tax rate may be only 20%. By using this disparity in tax rates, the tax code is rewarding those who get “unearned” income from investments, and the tax code is punishing those who get “earned” income from working as an employee.

We believe that donating money to a church or charity is a good behavior and encourage it with a tax deduction reward. We believe that saving money for retirement is good behavior and encourage it by deferring income taxes on money deposited to an IRA or a 401(k) account.

And we believe that running a business is a good behavior – so we allow businesses to deduct many expenses that, as individual taxpayers, we would just have to absorb. These deductions are all rewards for running a business. (Or, thought of another way, you are punished for being an individual income earner by being denied these deductions.)

Channelling is an important element of the tax system. We have no other way of rewarding – therefore, encouraging – good behavior. And we can’t punish – therefore, discourage – bad behavior except by making it illegal, and our Constitution and other rights often prevent us from doing that.

This is an aspect of the tax system that isn’t thought about often, as a taxpayer. We make these choices, thinking we’re doing the right (or wrong) thing, and then enjoy (or suffer) the tax consequences.

But when we’re thinking about TAX REFORM, we should be asking about this whole system of rewards and punishments, of taxes and deductions and exemptions and credits.

Why are businesses taxed at a different rate than individuals? Why do businesses get to deduct expenses but individual employees are not? Why are mortgage interest payments deductible but credit card interest payments are not? Why are charitable donations deductible but political donations are not? Do tax cuts really create jobs?

TAX REFORM puts a lot of these questions back into the conversation. They should never have left.

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