A Cap for Deductions?

by Mario Rizzo

The New York Times reports today that the Democrats are searching for a way to get additional tax revenue from “the rich” in a way that might garner Republican support. So they are bringing up an idea suggested by Mitt Romney in the presidential campaign to limit deductions to a specified aggregate amount.

How such a proposal would work out in practice depends on the details. The first point is the status of the charitable contribution deduction. Is that included in the limit or not? If it is, then one should expect charitable contributions, especially the large gifts, to fall. Beyond the political reprecussions, there are substantive issues. In a world so dominated by the “compulsory charity” of the state do we want to reduce private-based alternatives? This is a tough issue.

On the other hand, if we exclude charitable deductions (as some “Democratic centrists” — New York Times‘s label —  want), then we have opened the door to exception-making and special interest pleading. What about the home-mortgage deduction? I can see it now,”At a time when the housing sector is just starting to get on its feet…” And “the state of the housing sector has important macro-economic effects.” And so forth…

Of course, this would be an increase in effective marginal rates since as income rises you must pay the old rate (let us say) on a greater amount of your income.

So this is what the election was all about? I am afraid so.

8 thoughts on “A Cap for Deductions?

  1. If we go that route, then, yes, we should include charitable deductions in the limit. I am really not too comfortable with having government decide what is and is not charitable and what is and is not a religious institution. As I see it, most churches now are devoted to the programs of the Democrat Party and are therefore as more political than religious. The same is true to some extent of socially conservative denominations.

  2. I am puzzled. In today’s Financial Times Glenn Hubbard (a Romney advisor) has an opinion piece in which he suggests an increase in taxes on the rich by caps or elimninating deductions will increase average taxes but not marginal tax rates. Unless he is being legalistic, if you decrease deductions for upper income tax payers but not for lower, have you not increased effective marginal rates?

  3. Further demonstration of how little difference exists between Democrats and Republicans.

    BTW, the Adam Smith Institute came out in support of the Libertarian candidate before the election in their blog.

  4. Mario Rizzo – According to your words, Hubbard said tht there would not be an incrase in “marginal” tax rates, or the tax rate on the last/next dollar of income. This is true. There would, however, be an increase in the “effective” or overall, tax rate, since the total tax paid would be a larger dollar amount on the same income.

  5. The only way this is not an effective marginal tax rate increase is if your charitable giving is fixed and independent of your income. This plan raises every marginal rate in the top bracket to 33% regardless of giving. Raising taxes this way does not increase the maximum possible marginal rate beyond 33%, but it’s misleading to claim this isn’t a marginal rate increase.

  6. Do you really think Obama can achieve something by that? Why isn´t he scared Republicans would oppose his proposal, just because they would want some minor changes. And would it finally erode the support Obama has as the President. I know it is his second mandate and he can´t lose anything, but still… I´m scared that negotiation would not lead anywhere, especially with other Obama´s proposals such as Medicare. And Republicans need to maintain strong opposition in order to be able to compete in the next presidential election.

    About the taxes, I think Obama has to present a major reform. It is not about taxing the rich, but about increasing the effectiveness of the taxation. It is completely naive to think that increase in the taxation of the rich people would lead to major revenues. But there has to be a way out of this. President has to offer something in exchange. Maybe more social programs. Americans are facing one of the worst situations in the last fifty years, poverty raises, there is significant immigration to Canada, which has higher taxes… So the question is, what do you offer, Mr. Obama?

  7. Wouldn’t one of the biggest consequences of a deduction cap be non-deductibility of state income tax payments for people living in NY, CA or MA, for starters?

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