Cut deductions to lower tax rates? Easier said than done.
Two interesting new papers from the Congressional Research Service highlight a聽major challenge faced by聽any tax reform that reduces itemized deductions to help pay for lower tax rates鈥攍ots of middle-income people would lose at least some benefits from scaling back those deductions.
It isn鈥檛 a new lesson, but it is one that bears repeating. For instance,聽聽shows that in 2010 about 40 percent of all deductions were claimed by households making between $20,000 and $100,000, with 28 percent going to those making between $50,000 and $100,000. Nearly half of tax filers making between $50,000 and $100,000 claimed deductions for mortgage interest and charitable giving, and more than half deducted state and local taxes.
Those three deductions alone represent more than two-thirds of all itemized deductions. Thus, it is hard to imagine any base-broadening, rate-cutting reform plan that doesn鈥檛 include some cuts in those preferences. And taking that step threatens to make a lot of middle-income taxpayers very unhappy. As Bruce Bartlett (who tipped me off to the CRS papers in his聽聽this morning) notes, this may explain why so few tax reform plans ever identify a single tax preference they would target.
Of course, higher income people disproportionately benefit from many deductions. For instance, the Tax Policy Center聽聽that households making $500,000 or more represent less than 1 percent of all taxpayers. Yet, CRS estimates they claim about 15 percent of all deductions.聽
But middle-income taxpayers may be聽more interested in what they鈥檇 lose, not in their hit relative to the wealthy.
In a聽, CRS figures that wiping out all deductions would boost effective marginal tax rates by 4.4 percentage points. The actual winners and losers, of course, can鈥檛 be identified without also looking at how any specific plan reduces rates. It is possible to redesign rates in a way that middle-income people, on average, pay the same total tax as they do now. But it isn鈥檛 easy. And even if Congress pulled it off, there would still be winners and losers within income groups. 聽聽聽聽
An important caveat: The CRS papers, written by Jane Gravelle and Sean Lowry, look only at itemized deductions. They ignore other tax preferences such as the exclusions for employer sponsored health insurance and contributions to tax-preferred savings accounts such as IRAs and 401(k)s. But as my Tax Policy Center colleagues聽, millions of middle-income households also benefit from those preferences, further buttressing the argument that these taxpayers would face severe sticker-shock from the Great Reveal of any tax reform plan.
Like a lot of the聽聽that my TPC colleagues have done in recent years, the CRS paper does not discredit tax reform efforts. But it does show how challenging they will be. Tax wonks won鈥檛 be surprised by the CRS findings but politicians may be. That鈥檚 why they鈥攁nd you鈥搒hould read the paper.
