Libertarian Land: The First Amendment, Taxes, and Religion

The First Amendment to the Constitution says, inter alia, that “Congress shall make no law respecting an establishment of religion, or prohibiting the free exercise thereof.”The natural interpretation is that, under the Constitution, policy must be neutral toward religion, neither penalizing nor subsidizing in any way.The United States, however, subsidizes religion substantially, via the tax code.The federal and most state income tax systems allow religious institutions to choose non-profit status, which exempts their income from taxation. Contributions to religious institutions are tax deductible for the donor, and local governments exempt religious institutions from property taxation.Current policy thus subsidizes religious activity. A church that holds prayer services every Sunday, funded by contributions, pays no taxes on the difference between its revenue and costs, or on the value of its land and buildings. Donors also get a tax deduction.In contrast, a football team that plays every Sunday, funded by ticket prices and TV revenues, pays tax on its profits, as well as on its property. And setting aside fans who can charge football tickets as a business expense, most get no deduction for their “contributions.”This differential tax treatment makes it cheaper to fund religious activity relative to anything not eligible for non-profit status, thus shifting society’s resources toward religion (and other activities eligible for this status, such as charities and educational or scientific organizations).The tax system could be neutral, however, in one of three ways.The most obvious approach is to eliminate any distinction between for-profit and not-for-profit activity, instead applying the same tax rates and rules to all business income, regardless of source. Local government could similarly impose the same tax rates on all property, independent of how used.A second approach is to eliminate taxes on business income generally (in particular, repeal the corporate income tax) and attribute all income to the business owners (as occurs now for non-corporate businesses). This makes economic sense, since individuals ultimately bear the burden of all taxes (if you can’t shake hands with it, it doesn’t pay taxes). Tax rates on personal income could adjust to produce the same total revenue.A third approach is to tax consumption rather than income, via sales or value-added taxes.Under any of these approaches, the tax code makes no distinction—explicit or implicit—between for-profit versus non-profit activities. Some activities might still organize as non-profits, returning their “profits” to customers rather than owners. Government, however, would play no role in such decisions.These alternative systems have several advantages beyond neutrality toward religion.While in principle a separable issue, elimination of the non-profit distinction also makes it natural to eliminate deductions for charitable activities. Combined with the neutral treatment of business income and property, this would make the tax code neutral across the board. Eliminating the corporate income tax avoids double taxation of corporate income, increases transparency in corporate accounts by removing any need for separate financial versus tax reporting, and stops incentivizing business decisions that make sense for tax reasons but not otherwise. Consumption taxation encourages savings rather than consumption and thus spurs capital accumulation and economic growth.Most importantly, the power to define non-profit status gives the government enormous power to define, promote, or punish not just religion but also education and private charity.That power is easily misused.The power to define what constitutes non-profit activity allows government to make arbitrary distinctions about what kind of education is beneficial to the citizenry and therefore eligible for this status (e.g., liberals arts versus vocational and technical training).This power allows government to support long-standing charities or religions relative to new ones, based on entrenched interests rather than the public’s preferences.This power implicitly allows governments to mandate or outlaw specific religions, as many have done.The First Amendment’s establishment clause is clear: policy must be neutral toward religion, but current tax policy is not. Both those who favor religion, and those who do not, would be wise to endorse neutrality because any power in the hands of government can, and eventually will be, abused.

Libertarian Land: The First Amendment, Taxes, and Religion

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