Why deduction caps are a great idea

By Felix Salmon
October 4, 2012

If there’s one thing that Democrats and Republicans always agree about, it’s the importance of closing loopholes in the tax code. And if there’s one thing that Democratic and Republican administrations are equally incapable of doing, it’s closing loopholes in the tax code. Every loophole has its associated lobby; many of those lobbies are extremely powerful, and all of them are extremely vocal when it comes to their particular carve-out. And when you have powerful and vocal lobbyists on one side, and no one with much of a dog in the fight on the other side, the powerful and vocal lobbyists tend to win.

Which is why I’m a fan of the capped-deduction idea that Mitt Romney first floated on Tuesday, and then brought up again in the debate last night. Here’s what he said on Tuesday:

As an option you could say everybody’s going to get up to a $17,000 deduction; and you could use your charitable deduction, your home mortgage deduction, or others – your healthcare deduction. And you can fill that bucket, if you will, that $17,000 bucket that way. And higher income people might have a lower number.

And here’s what he said in the debate:

I want to bring down the tax burden on middle-income families. And I’m going to work together with Congress to say, OK, what — what are the various ways we could bring down deductions, for instance? One way, for instance, would be to have a single number. Make up a number, $25,000, $50,000. Anybody can have deductions up to that amount. And then that number disappears for high-income people. That’s one way one could do it.

Romney’s a step ahead of his campaign, here. When pushed for specifics, spokeswoman Andrea Saul has nothing, saying only that “Gov. Romney referenced one illustrative example” of a way in which he might possibly get revenues without raising taxes. The lack of detail was immediately seized on by the Obama campaign, which decided that if Romney wasn’t going to be specific, then it obviously had to include the healthcare exclusion — the way in which Americans don’t pay taxes on health-insurance costs borne on their behalf by their employer.

But Romney never mentioned exclusions, only deductions. This is hair-splitting territory, but if you’re the kind of person who itemizes your deductions, you know what you’re deducting. The big ones are your state and local taxes; your charitable contributions; and your mortgage interest payments. Meanwhile, you probably don’t even know how much your employer is spending on your health insurance.

And frankly I’m disappointed in the Obama campaign’s response: they’ve come out, now, with a simple argument: any attempt to cap deductions would constitute a middle-class tax hike. Obama won’t raise taxes on the middle class. Therefore, Obama is opposed to any attempt to cap deductions. That’s sad, because in principle the idea is a very good one. And it’s also sad because it reveals that the Obama campaign simply isn’t serious about closing loopholes.

After all, there are lots of ways to close loopholes in a revenue-neutral way, so that the middle class in aggregate pays no more taxes than it does right now. But if you’re attacking deductions, then by definition the people who take those deductions are going to lose out. And if you’re promising that no individual middle-class family will see their taxes rise, then frankly you’re not being serious about tax reform at all.

The Tax Policy Center has an excellent overview of who itemizes deductions. Overall, there are about 158 million “tax units” in America, of whom about 47 million itemize deductions at all. That’s 30% of the total. And if you slice off the people with incomes in the top 20%, then you’re left with 28 million tax returns which itemize deductions out of 135 million returns filed, which is basically just one in five. You could completely eliminate all tax deductions tomorrow, including the horrible mortgage-interest deduction, and taxes wouldn’t rise for the vast majority of Americans. But if you commit to not raising taxes for those 28 million households who do deduct, then you’re never going to get anywhere.

And the Romney approach is a really good one because it dilutes the power of any individual lobby. He’s not picking favorites here, retaining the charitable-contribution tax deduction, for instance, while abolishing the mortgage-interest deduction. He’s saying that you get to keep whatever deductions you like — just up to a certain limit. Martin Feldstein has proposed something similar: his 2% cap would raise $278 billion, which is real money. And Romney actually goes further than Feldstein: instead of the cap rising with income, as Feldstein’s does, Romney’s falls with income, and indeed it entirely “disappears for high-income people”. If you’re high-income, you get no deductions at all.

This would have a massive effect on Romney himself, who gives millions of dollars to charity every year. What he’s saying — and this is a praiseworthy and honorable thing — is that he gives to charity because it’s the right thing to do, rather than because he gets to donate pre-tax dollars. He will continue to give to charity, even if the charitable tax deduction gets abolished, and he will continue to minimize his taxes, as is his right. But he’s just not going to be able to do both at the same time any more, which is fine.

What’s more, the cap on deductions is a bit like the emissions cap in a cap-and-trade system: once implemented, it can be dialed up and down relatively easily. Any time you need a bit more on the revenue side of things, you dial it down. Any time you want to be able to say that you’re doing wonderful things for charities and non-profits, you dial it up. (And in doing so, you’ll get a very handy natural experiment: we’ll really see, with hard empirical data, just how many marginal extra charitable cents get donated for every dollar of charitable-deduction tax expenditure.)

I don’t believe for one minute that even a complete repeal of all deductions would be enough to counteract the 20% across-the-board tax cut that Romney says he wants. But that’s where scoring comes in: presidential candidates can say whatever they like, while presidents, if they’re proposing something revenue-neutral, need the CBO to score it that way.

Romney came out and said, in the debate, that “you’ll never balance the budget by raising taxes” — which is equivalent to a businessman saying that you’ll never increase your revenues by raising your prices. I don’t take his fiscal-policy rhetoric seriously, and I don’t know anybody who thinks it adds up. But all the more reason, then, to welcome sensible proposals when they do occasionally emerge from his camp.

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