The passage of Trump’s “one big, beautiful bill” has once again raised the issue of tax loopholes.
The One Big Beautiful Bill Act (OBBBA) was signed into law by President Trump on July 4. It includes a number of provisions related to income taxes. It increases the standard deduction, introduces a temporary increased extra standard deduction for seniors, temporarily exempts earnings from overtime and tips from income tax, raises the child tax credit and makes it permanent, temporarily increases the SALT deduction, phases out clean energy tax credits, allows taxpayers to temporarily deduct car loan interest payments, raises taxes on university endowments, and raises the estate tax exemption.
There are two ways the federal tax code reduces the amount of income tax paid to the government. Tax deductions reduce the amount of one’s income subject to tax. One will pay less in income tax the greater the number, and the greater the amount, of deductions that one qualifies for.
Tax credits are a bit different. They reduce the amount of one’s income tax owed. Regular tax credits may reduce the tax owed to zero, but if there is no taxable income to begin with, then no credit can be taken. Refundable tax credits are treated as a payment from the taxpayer like federal income tax withheld or estimated tax payments. However, if the tax credit “payment” is more than the tax owed after the regular tax credits are applied, then the “taxpayer” receives a “refund” of money he never actually paid in.
Tax deductions and credits (unless they are refundable) are always a good thing because they allow Americans to keep more of their money out of the hands of the federal government. They are not “loopholes” that need to be closed. Eliminating or reducing the value of tax deductions or credits has the same effect as raising tax rates: more taxes paid to the government. Any attempt to eliminate or reduce tax deductions or credits should be seen as support for raising taxes, no matter what justifications are put forth by some libertarians.
According to the IRS, as a result of the OBBBA, for tax years 2025 through 2028, qualified tips up to $25,000 are tax deductible, overtime pay (the “half” portion of “time-and-a-half” compensation) up to $12,500 ($25,000 for joint filers) is tax deductible, and interest on car loans up to $10,000 is tax deductible. These deductions are available for both itemizing and non-itemizing taxpayers. However, the tip and overtime deductions phase out “for taxpayers with modified adjusted gross income over $150,000 ($300,000 for joint filers)” and the interest deduction phases out “for taxpayers with modified adjusted gross income over $100,000 ($200,000 for joint filers).” Also effective for tax years 2025 through 2028, “individuals who are age 65 and older may claim an additional deduction of $6,000” that is “in addition to the current additional standard deduction for seniors under existing law.” However, the deduction phases out for taxpayers with modified adjusted gross income over $75,000 ($150,000 for joint filers). Another temporary provision of the OBBBA is an increase in the State and Local Tax (SALT) deduction to $40,000 for five years. Permanent provisions include an increase in the child tax credit to $2,200 and an increase in the estate tax exemption to $15 million.
In addition to loopholes instituted or perpetuated by the OBBBA, some libertarians perpetually harp on the exemption for municipal bond interest and the health-care exclusion.
Municipal bonds are financial instruments issued by state and local government entities, typically to fund public projects. The income they generate is generally exempt from federal income tax and state and local taxes.
The health-care exclusion refers to employer-paid health insurance premiums being exempt from federal income and payroll taxes instead of being treated as taxable income to the employee. Some libertarians consider this to be the worst loophole in the tax code because it costs the federal government hundreds of billions of dollars each year. These libertarians naïvely just assume that absent the health-care exclusion, employers would redirect their spending on health-care insurance premiums to employees so that they can control all their earnings.
Libertarians who say that certain tax deductions and credits are loopholes that need to be closed argue that these loopholes distort the tax code, are inefficient, subsidize high-income taxpayers, interfere with the free market, and encourage people to make economically unwise decisions.
They may be all those things and more, but what is the effect of reducing, phasing out, or eliminating them? The effect is higher taxes and more revenue for Uncle Sam.
Austrian economist Murray Rothbard referred to the idea of a tax loophole that needs to be closed as a great economic myth:
A deduction or exemption is only a “loophole” if you assume that the government owns 100% of everyone’s income and that allowing some of that income to remain untaxed constitutes an irritating “loophole.” Allowing someone to keep some of his own income is neither a loophole nor a subsidy.
Only those who think that the government has an absolute right to a percentage of all income produced and that tax deductions and credits deprive the government of its claim to that percentage could object to individuals holding on to more of their money.
Americans are quadruple taxed on their income. First, there is the federal income tax. Second, on the same income, there is the Social Security tax of 12.4 percent (split equally between employers and employees) on the first $176,100 of employee income. Third, on the same income, there is the Medicare tax of 2.9 percent (split equally between employers and employees) on every dollar of employee income. And fourth, on the same income, there is state income tax in 41 states.
It is too bad that libertarians who are so adamant about tax loopholes being closed don’t expend the same amount of energy making the case for lower tax rates, the canceling of refundable tax credits, the repeal of payroll taxes, and the elimination of the income tax altogether.
Because Trump’s tariffs could never raise enough money to replace the income tax, because the income tax is not going to be repealed any time soon, and because taxation is theft, libertarians should support increasing the size and scope of every possible tax credit, deduction, and loophole since they are some of the few ways that Americans can hang on to more of their money.
