Comments on: Why deduction caps are a great idea A slice of lime in the soda Sun, 26 Oct 2014 19:05:02 +0000 hourly 1 By: andersb Wed, 10 Oct 2012 22:30:58 +0000 I agree with the theoretical benefits of eliminating exclusions and deductions. (Although I am concerned about the distributional effects of such a plan; it seems highly likely that the middle 3/5s of the country would have to pay more in federal taxes to make the math work. If we could raise the tax on capital gains and dividends up to the 25% range at the same time, I’d probably be more bullish.)

My point here though is that I don’t think a deduction cap accomplishes any of the goals of tax reform centered around lowering rates and eliminating deductions. We now seem to be in agreement on that as far as I can tell. The “seven different pre-tax deductions” would still be on your paycheck, as would the other deductions and credits. The phaseouts would likewise still apply.

The only potential accomplishment that I see is a (modest) lowering of marginal rates. But I don’t see why that is necessarily a positive thing if the effective rates don’t change much (they would go down for some people and up for others). How many Americans have any clue what their marginal tax rate is? And what subset of those people make decisions about working more, or making deductible payments, based on that rate?

Lastly, and mostly unrelatedly, why does Romney get to go around touting a 20% tax “cut” that he claims is revenue neutral? Either he is proposing a tax cut or he is proposing revenue neutral reform. It can’t be both.

By: TFF Wed, 10 Oct 2012 20:10:33 +0000 @andersb, I would rather eliminate the deductions, exclusions, and credits all together. I agree that a deduction cap would further complicate the system (never a positive).

No system will ever be wholly fair, so you might as well stick with something simple. We have seven different pre-tax deductions from our paychecks, four or five different major items on Schedule A, and a handful of credits which each come with a different cap or phase-out. We can’t even calculate the tax owed without going through a page-long form on the back of Schedule D.

By: andersb Tue, 09 Oct 2012 15:12:40 +0000 @TFF

But are any of those three things accomplished with a deduction cap in the range of $17,000 per year?

1) the existing distortions caused by things like the mortgage interest deduction (or the arguably more problematic exclusion from income for employer provided health insurance) will nearly completely stay in place. Arguably they will completely stay in place because taxpayers / potential home buyers will not understand the impact of the deduction cap.

2) simplicity? This proposal would simply add a layer of complexity. It would be very difficult to know, in the early months of a given year, whether a particular payment will be eligible for an income tax deduction. And when it comes time to prepare one’s taxes, you would have to first enter your itemized deductions (and all the work that entails) and then check to see whether the cap impacts your results. (and then on top of that still have to work through the alternative minimum tax).

3) I don’t see how transparency is changed much here. It might even be worse if the cap applies to a bunch of households in the $150k-$300k income range while people like Romney continue to pay a 15% tax rate on nearly all of their income. Additionally, the cap would presumably not apply to ordinary and necessary business deductions, so there would still be anecdotes about small business owners taking tax deductions for cars and phones mostly acquired for personal use.

I don’t mean to say that the goals you have identified are unworthy goals. Quite the opposite actually – I think they are right on the money.

However, I don’t think the deduction cap idea materially advances any of them (unfortunately).

By: TFF Tue, 09 Oct 2012 00:03:11 +0000 @andersb, I would offer a few possibilities (some of what you touch on).

(1) Law of unintended consequences. Credits/deductions are frequently a ham-handed attempt to manipulate economic behavior, or to make the system “fairer” for some disadvantaged group. Yet for every inequity they resolve, two new ones are created. Could argue that tax policy contributed to the mortgage bubble.

(2) Simplicity. Shouldn’t require a college degree and a $40 computer program to file your taxes (we don’t do anything terribly unusual). These days, nobody but an expert is aware of all the possible deductions/credits out there.

(3) Transparency. Better for all if people can trust that everybody is paying their fair share. If they suspect the system is slanted to the advantage of somebody else, they get resentful.

By: andersb Mon, 08 Oct 2012 16:24:41 +0000 Felix,

I would like to step back and ask why you think “tax reform”, and especially tax reform centered on lowering rates while trimming deductions, is a good idea. Why do you think it’s a good idea?

Possibilities include:
1) eliminating wasteful deductions and credits that were maybe once a good idea but which are no longer worth their cost;
2) providing a more transparent income tax system so that workers can properly assess the marginal benefits and costs of earning higher wages;
3) cost savings from simplified tax filings; and
4) ?

It seems to me that the $17,000 cap on deductions, while a politically elegant way to limit deductions without battling over specific deductions, serves no practical purpose. At least it does not seem to accomplish any of the goals I’ve listed above.

Why would a tax system with marginal rates that are, say, 5% or 10% lower, coupled with even more complexity around deductions and credits, be a better tax system?

And if we are looking to have revenue neutral tax reform (which apparently everyone in Washington has agreed to), isn’t the only point to enact a system that is in some way “better”? Why else are we shuffling chairs around?

By: y2kurtus Sat, 06 Oct 2012 02:26:46 +0000 The middle class is usually defined as the middle 3/5ths of the income curve.

If you split out each 3rd of the middle class you learn that the lower middle is mostly untaxed at the federal level. Payroll taxes are meaningful but do not even cover the direct benefits tied to them. This leaves basically no contribution for any discretionary spending.

It is much more complicated for the middle middle and upper middle. Some like me pay almost nothing due to broad categories of the largest deductions. Childless renters who don’t provide for their own retirement are badly discriminated against by the current code.

One could quite accurately point out that a society made up exclusively of childless renters who don’t provide for their own retirement would fail within 1 generation… but rather than get into that counterproductive debate… I’ll just admit that as a group, people in the upper half of the middle class DO NOT PAY THEIR FAIR SHARE in the current system.

By: QCIC Fri, 05 Oct 2012 17:24:07 +0000 The bottom line is the tax rate should be a levy dependent on the spending, solves all these problems. Then the politicians can just bicker about how the levy is distributed, but there won’t be any more handing out of goodies without people paying for them.

By: srb4761 Fri, 05 Oct 2012 12:41:27 +0000 I’m sorry, but I am missing the point of lowering headline rates and then introducing a deduction cap that depends on income. Start with state tax deduction. That has the effect of lowering effective state marginal tax rate. If I reduce the federal rate but eliminate state deduction, that just (partially) offsets reduction in my federal rate with an increase in my effective state rate. What’s the benefit compared to a smaller reduction of federal rate and preserving deductibility.
Phase out of total deductions is even more perverse: it introduces a upward bump in the effective tax rate over the income range of the phase-out, which then disappears for higher income. So you end up with a marginal rate for the highest earners that is lower than those whose earning are in the phase-out range.
This stuff just adds complexity without accomplishing anything – if you think the rate cut loses too much revenue, cut rates by less.
I’m fine with limiting the mortgage deduction if we want to limit subsidy to mortgages – but cap it for everyone. Same with charity. These things are not “loopholes” – they are deliberate tax expenditures for specific purpose, if we don’t think the purpose is worth the cost, limit or get rid of it. But making the amount deductible depend on income just introduces weird marginal rate effects which defeat the (presumed) purpose behind lowering marginal rates.

By: y2kurtus Fri, 05 Oct 2012 12:36:12 +0000 I am in approximately the 65 income percentile of US households (top 5 percent of globally.) I get:

15,000 in retirement contributions on which my taxation is deferred into the future.

14,000 in mortgage interest on a 1st home.

12,000 health insurance deduction (half that amount if you exclude the share paid by my employer.)

8,000 worth of deductions (which are really 2k in credits multiplied by the inverse of my marginal rate.)

So I have roughly 50,000 in deductions. TFF accurately points out that I pay property taxes, sales taxes, state income taxes… but the feds get only a modest contribution from me.

In the 65 percentile of income my federal government spends 4 times what they collect from me per capita. That’s a fairly progressive system as it stands.

By: KenG_CA Fri, 05 Oct 2012 04:25:01 +0000 TFF, you’re right about that, but I still don’t like the idea of credits or deductions for every charitable contribution. In many cases, it violates the separation between church and state, as it effectively has the government contributing to religions.