If you want a concrete example of the unanticipated harm that could come from the U.S. going over the fiscal cliff, look no further than Build America Bonds, an efficient alternative way to subsidize state and local investments. They are part of the spending that is scheduled to be reduced in January.
Build America Bonds, which were created in the 2009 stimulus bill, are a shining example of the right way to subsidize activities through the tax code. The wrong way --which is also the way virtually all other tax subsidies are structured -- is to provide a tax deduction or exclusion. This means that the tax break per dollar of subsidized activity varies with the taxpayer's marginal rate, and that is both unfair and inefficient.
Consider, for example, the exemption allowed for interest paid on state and local bonds. A high-income taxpayer gets a larger tax break for each $1 of interest paid on the bond than a middle-income taxpayer who owns the same bond does. This creates a windfall for high-income taxpayers, a variety of analyses have concluded. The interest rate on state and local bonds falls by less than the tax break the high earners enjoy. As a result, only about 80 percent of the forgone federal revenue shows up in reduced state and local government borrowing costs.