Why I favor taxing subsidized goods
By Scott Sumner
A number of people have asked me why I opposed the repeal of the medical devices tax. Taxes generally create deadweight losses, as they reduce output to a position below the socially optimal level (which is usually the free market level.) There are a few exceptions:
1. Taxes on externalities, such as pollution.
2. Taxes on goods that are already heavily subsidized.
Here’s the standard graph showing the deadweight loss from a subsidy:
Recall that a subsidy will tend to increase output and reduce government revenue. A tax imposed on this same good will reduce output and increase government revenue, essentially reversing the effect of the subsidy, and thus moving you back closer to the optimal level of output.
Of course you can overdo it, but the medical devices tax was far smaller than the subsidy on medical devices, which is enormous. (Subsidies include Medicare, Medicaid, tax deductibility of insurance, etc.) So the medical devices tax was a modest step in the right direction. And now it is to be abolished. I wouldn’t object to its abolition if they had also abolished government subsidies such as the deductibility of health insurance. They should have abolished that tax deduction, and replaced it with a fixed tax credit for anyone with company provided health insurance plans. (Then they would no longer need the Cadillac Plan tax either. I seem to recall that John McCain once proposed this approach.)