Unproductive Incentives

By Ramesh Akkineni

from an article by Chandrakant Sampat

Grave distortions are caused when tax exemptions are present for they are inducements to behave in a manner which would not be otherwise economically expedient. Tax exemption amount to little else than bribes to tax payers causing them to act in a suboptimal manner. This causes scarce resources to be channeled into activities that are not necessarily in the interest of the nation. In other words, deduction cause misallocations and hence the bubbles.
Take the example of deduction of interest on housing loans. Peter Drucker in “Managing in Turbulent Times”, stated: “The home is a durable consumer good, albeit one that has a high resale value. It is not a “capital good” used to produce economic value or wealth. Investment in the home is not “capital formation.”
With the allowance of deduction of interest on housing loans, many taxpayers are taking loans and buying houses, causing a bubble in the real estate market. Furthermore, houses are non-productive assets and the concomitant diversion of resources to houses with the easy availability of loans amounts to a costly economic distortion.

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