Tax Expenditure Reform Should Complement an End to the High-End Tax Cuts
While many tax expenditures (deductions, credits, and other preferences) are costly and inefficient and should be reformed, such changes should complement — not replace — letting the high-income Bush tax cuts expire, as our new report explains:
Some people have suggested capping itemized deductions for taxpayers with incomes over $250,000 (for couples) and $200,000 (for singles) as an alternative to letting President Bush’s tax cuts for these taxpayers expire on schedule. To raise the same amount of revenue, however, would require tax changes that pose serious problems from a policy standpoint and would likely prove politically unacceptable. Thus, such an approach would likely raise substantially less revenue than letting the high-income tax cuts expire.
To even come close to replacing the revenues from letting the high-end tax cuts expire with a cap on itemized deductions that targets high-income taxpayers and does not affect middle-class families, policymakers would have to virtually eliminate all itemized deductions for households with incomes over $250,000. Moreover, to avoid a massive increase in effective tax rates, policymakers would have to phase the cap in over an extended income range above the $250,000 level, reducing the revenue it would generate.
A cap on all itemized deductions would eliminate incentives for affluent individuals to make charitable donations once they had reached their limit on deductible expenses for items such as mortgage interest and state and local taxes. Besides, policymakers may well be hesitant to apply a tight cap on deductible expenses for financial transactions such as existing home mortgages. Given the effect that such a cap would have on charitable contributions and certain other activities — and the protests that would ensue — there is serious question as to whether policymakers would really enact a robust deductions cap and, if they did so, whether it would endure for long and actually be allowed to take effect or would subsequently be scaled back or repealed. . . .
The expiration of the Bush high-end tax cuts is sound policy that would save $968 billion in revenues over ten years, make the tax code more progressive, have little effect on the economic recovery, and improve long-run growth by helping shrink the deficit and thereby increasing the pool of national saving available for private investment. Once assured of the deficit reduction from allowing these tax cuts to expire, policymakers can turn to the complementary and necessary, but difficult, task of tax-expenditure reform as part of a balanced approach to fiscal consolidation.