Targeted tax credits artificially lower prices of government-approved activities while increasing other prices throughout the economy. The distortion of relative prices alters taxpayers' behavior and disrupts the efficient operation of markets. In effect, the government, rather than the market, determines where resources should be allocated. In contrast, broad-based tax reductions minimize distortions in resource allocation because relative prices remain unchanged. In this way, the tax policy is guided by neutrality, permitting market incentives to allocate resources to their most highly valued uses.
Taxes affect economic behavior and decision-making, which in turn affects the economy.
There are two main reasons why the incentive effects of a broad-based tax reduction are superior to those of narrowly targeted tax policies such as tax credits. Narrowly targeted tax credits do not have this effect because they do not lower the marginal tax rate. Second, narrowly targeted tax measures cannot increase overall economic activity, but only rearrange it in a less efficient manner. Certain activities may be promoted, but this will be at the expense of other activities which are already operating efficiently in the market. For example, a tax credit for education may alter educational decisions to some extent, but it does not lower marginal tax rates on working, saving or investment.