About tax credits A tax credit is subtracted from taxes owed by the taxpayer Advantages: An immediate lowering of tax due, or increase of refund. Disadvantages: The consumer may make poor economic choices by being overly swayed by the tax credit Some consumers have also been pursued for overpayment of tax credits, leading to financial hardship.

Why tax credits? Tax credits can be used by the government as an incentive towards economically desirable behavior. Such tax credits include those for hybrid cars, energy-efficient housing, and working low-income parents. These credits directly pay consumers for making socially responsible or politically desirable choices.

Problems Consumers may unduly weigh the tax credit in their decision making. An individual might decide to invest $10,000 in windows to gain a $1000 tax credit. If individual pays for the windows on a credit card and does not pay off the balance, s/he will easily spend the tax credit on interest within a year.

Why tax credits are a dangerous tool If energy-efficient doors and windows are the most important thing that consumers can do to resolve the current energy crisis, then the tax credit makes sense. However, the money they spend to upgrade their windows will then be unavailable for other possible solutions, such as buying a hybrid car or insulating their homes. The opportunity cost may be immense. It is a one-size-fits-all solution to a complex problem.

Use of the credit Most consumers will look at a $1000 tax credit as a “windfall,” and will spend it immediately. In reality, the money is already spent, as the credit does not cover the entire cost of the doors and windows that they were incentivized to purchase. The only economically sensible thing to do with the credit would be to put it into savings or toward the bill for the home improvements.