Tax hikes conservatives can love
Though it is hard to tell exactly how the fiscal cliff tug-of-war will end, what we can say is that Democrats and Republicans have been drearily unimaginative. President Obama wants to see the top two federal income tax rates increase above their current levels.
Obama has called for a top rate of 39.6 percent, though he has signaled a willingness to compromise on a somewhat lower rate. While he has said he is open to entitlement reform in some vague way, he has so far refused to be pinned down on the details. Essentially, he is asking congressional Republicans to make a big concession on taxes and to trust that he will honor his end of the deal by agreeing to embrace spending restraint in 2013.
Republicans are by and large opposed to a top tax rate above today’s 35 percent. Though they too have been light on details, many have instead embraced sharp limits on popular tax exemptions for high earners to raise revenue. Others have suggested they’d be willing to budge on tax rates. Representative Tom Cole (R-OK) has called on his fellow House Republicans to pass two bills, one that extends the Bush-era high-income rate reductions and another that extends everything else, with the understanding that the latter will become law while the former will fall into oblivion. This strategic retreat is designed to allow Republicans to use the forthcoming fight over the debt limit to secure, among other things, a hike in the Medicare eligibility age.
Rather than see Obama’s insistence on new revenue as a defeat in the making, Republicans could treat it as an opportunity to advance conservative policy goals. One of the most costly tax expenditures, for example, is the deduction for state and local taxes, which in effect subsidizes high-tax jurisdictions by softening the blow of high state and local tax burdens. Eliminating this deduction would make voters in states such as New York, New Jersey and California more tax-sensitive, which might make them more likely to back state and local candidates who promise a more cost-effective government.
Elimination of the deduction would also be a bonanza for the U.S. Treasury. In fiscal year 2011, the state and local tax deduction cost the federal government $70.2 billion in forfeited revenue. In April, the Committee for a Responsible Federal Budget estimated that eliminating the state and local tax deduction would raise $1.3 trillion relative to current policy (the tax rates that prevail today) and $950 billion relative to current law (the tax rates that will be in place if we go over the fiscal cliff) from 2013-2022. This alone would go a long way toward meeting Obama’s revenue goals. Even if Congress only eliminated the state and local tax deduction for households earning $200,000 or more, it would raise $500 billion relative to current policy.
The Tax Policy Center has analyzed a proposal that would limit eligible mortgage interest to the first $500,000 of a primary residence loan and transform the mortgage interest deduction into a nonrefundable tax credit equal to 15 percent of eligible mortgage interest. Relative to current policy, the Tax Policy Center estimated that this reform would generate $378 billion over the 2012-2021 budget window. It would raise $573 billion relative to current law. And it would have virtually no impact on well-functioning housing markets in regions with loose restrictions on homebuilding, or on middle-income households. Indeed, the nonrefundable tax credit would be a much a better deal for upwardly mobile middle-income families than the existing mortgage interest deduction. The economists Edward Glaeser of Harvard and Joseph Gyourko of Wharton have documented that apart from being wildly regressive, the mortgage interest deduction tends to push up housing prices in regions where new homes are in short supply.
As Peter Schweizer of the right-leaning Government Accountability Institute recently suggested, curbing the tax-exempt status of municipal-bond interest, an idea that White House officials and congressional Republicans are coming to embrace, would discourage local governments from accumulating debt for boondoggles like sports stadiums, convention centers, and shopping malls. The Joint Committee on Taxation estimates that this measure would yield $124.4 billion over the next decade. Even if we were to shrink that number considerably, the benefit of putting the brakes on wasteful projects nationwide would be well worth making a change.
And then there is the charitable tax deduction, which in its current form does little to benefit the large majority of low- to middle-income workers who do not itemize their taxes. The Committee for a Responsible Federal Budget crunched the numbers on what would happen if the charitable deduction were replaced with a 15 percent nonrefundable tax credit for all donations above 2 percent of income. Over the 2012-2021 budget window, this reform would yield $340 billion in new tax revenues. At the same time, as Mina Kimes observed in a recent article in Fortune, this new credit would prove enormously beneficial to religious organizations, as 67 percent of the donations made by households earning less than $100,000 are to churches, synagogues, mosques and affiliated charities. One can easily imagine religious donors, a crucial part of the conservative coalition, seeing the virtue of this approach.
Many on the center-left have attacked the idea of raising the Medicare eligibility age, and understandably so. This measure is not likely to save much money, and it arguably rests on the assumption that the president’s Affordable Care Act will remain in place to meet the health insurance needs of 65- to 67-year-olds left without access to affordable coverage. Yet conservatives could take a page from Yuval Levin, editor of the conservative policy journal National Affairs, and call for a graduated eligibility age.
One of the more striking demographic facts about modern America is that, while longevity is increasing dramatically for the well-educated, it isn’t increasing at all for those with less education. If anything, we’re seeing backsliding. To raise the Medicare eligibility age for all Americans would be to ignore this inequality. But by linking the eligibility age to lifetime earnings, we could guarantee that the Warren Buffetts of the world will put less of a burden on our old-age social insurance systems, while people with low lifetime earnings will be shielded from any change. The beauty of this approach is that it would capture virtually all of the net savings of raising the eligibility age, as poor workers over 65 would likely need public subsidies if they no longer had access to the Medicare program. More attractive still is the fact that graduated eligibility has been championed by Ezekiel Emanuel, a former adviser to the Obama White House on health reform.
None of this is to say that conservatives should cheer the fact that congressional Republicans have their backs against the wall, or that raising revenue is necessarily a good thing. But these reform measures will tilt America in a direction that is more fair and more free-market at the same time.
PHOTO: U.S. President Barack Obama steps aboard Air Force One in Philadelphia, Pennsylvania, November 30, 2012. During a visit to a Pennsylvania toy factory on Friday, Obama pushed for congress to resolve the issue of U.S. debt and Bush-era tax cuts that are set to expire at the end of the year. REUTERS/Jason Reed