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Wednesday, December 05, 2012

De-deducting your way to $800 billion in new revenue

Available information about Obama's fiscal proposal is surprisingly sketchy, unless I'm missing something.  Forgive me, then, if I get something fundamentally wrong here. But the proposal is said to closely track Obama's 2013 budget, and it seems to me that if you moderately expand a key revenue raising proposal in that budget, it would be possible to raise $800 billion in revenue over ten years by reducing deductions for the wealthy. Maybe not desirable as an opening gambit, but hardly mathematically impossible.

The provision in question, on page 39 of the budget, would reduce the value of itemized deductions and other tax preferences to 28 percent for families with incomes over $250,000 and individuals with incomes over $200,000 (at 2009 levels, to be adjusted for inflation).  That is, suppose you're taxed at a 33% rate and you make $3600 in charitable contributions. At present, deducting that amount would lower your tax bill by $1200.  At a 28 percent deduction level, your bill would be lowered by $1008; you would pay $192 more.  That change, across all deductions, is projected to reduce the deficit by $584 billion over ten years.

Suppose the value of itemized deductions were reduced to 25 percent rather than 28 percent? Wouldn't that get you to just about $800 billion?  Even better, I gather that many tax experts prefer tax credits, which reduce everyone's tax bill for a given behavior at the same rate, to deductions, which reduce them more for those who payer higher marginal rates. In other words, credits are a "flat tax deduction": everyone reduces their tax bill by the same, say, 20 percent for every dollar of spending they're allowed to count against their taxable income.  Surely there's some 'tax credit' level (or levels) that would raise $800 billion from the top two brackets without raising taxes on those in lower brackets.

Sunsetting the Bush tax cuts on marginal rates for the top two brackets, by way of comparison, would raise $849 billion over ten years, according to an OMB chart. (If I understand the CBO analysis right, that also includes raising the tax on capital gains to 20 percent; I'm not sure whether it includes taxing dividends at ordinary income rates, as Obama has proposed. )

I am presuming that reducing the value of deductions to 28 percent is in Obama's current proposal. It seems to fit the $600 billion slot in this brief outline of the tax provisions in the proposal posted on Wonkblog:
  • Immediate increase in both top marginal rates, as well as capital gains and dividends: +$960 Billion
  • Additional taxes: +$600 Billion
  • 2009-level estate tax
  • AMT and business tax extenders: -$236 Billion
  • Payroll tax extension or alternative policy: -$110B
  • Bonus depreciation extension
This outline doesn't quite track with the OMB chart of revenue raisers in 2013 budget linked to above.  There, the $960 billion would more or less include the estate tax; the breakdown is $849b for sunsetting the Bush rate cuts and $143b for the estate tax.  But $600b seems almost exactly right for the deduction limit, perhaps adding $13b for closing the carried interest loophole.  The budget's other revenue raisers pertain mainly to corporate taxes.

Again, I think Obama should go for the marginal rate hike first, as he's doing, and negotiate loophole-based revenue raisers later. But I don't know that he's making sense when he claims that the math won't allow a feasible $800 billion 10-year bite out of the wealthy via deduction reductions.

It does seem plausible that a higher deduction rate cap might be combined with a lesser marginal income tax rate hike to hit a "stage one" tax hike for the wealthy in the $800-900-billion-over-ten-years range.

Bloomberg's Julianna Goldman, who interviewed Obama yesterday, claims that "Obama’s budget plan includes more than $750 billion in revenue that could be generated from top earners by curbing tax deductions and credits." I don't know how she got to $750 billion, unless she either has access to a more detailed proposal that deviates from the 2013 budget, or is counting hikes in capital gains and dividend taxes as a form of "curbing tax deductions and credits" for top earners, or is counting corporate tax proposals.  But it's Goldman's article that made me look again at the $584 deduction "curb" in the 2013 budget. She did not respond to my request for clarification as to where the $750 billion figure comes from.

UPDATE (12/6): The Center on Budget and Policy Priorities analyzes the potential of Obama's deduction value cap to reduce the deficit, and points out that its deficit reduction value is reduced if the top marginal rates do not go up:
Limiting the value of certain tax expenditures.  The Administration’s proposal to cap the tax subsidy for itemized deductions and certain other tax expenditures at 28 cents on the dollar — which, as noted, would complement rather than replace an expiration of the high-end tax-rate cuts — is better designed.  It is progressive and retains a substantial tax incentive for deductible expenditures such as charitable giving.  Wealthy taxpayers would receive a 28-cent tax subsidy per dollar of charitable giving, so the limit should have only modest effects on total donations.[18]  The effects on the housing market and the availability of employer-sponsored health insurance would likely be similarly modest, particularly compared to approaches that wipe out most or all of those subsidies for many high-income taxpayers.

The design of the 28 percent limit means, however, that it raises considerably less revenue than allowing the high-income tax cuts to expire.  It would raise about $520 billion over ten years if the high-income Bush tax cuts expired.[19]  It would raise considerably less — roughly $300 billion — if the high-income Bush tax cuts were to continue, because this limit would shave tax expenditures by a considerably smaller amount if the top rate remained at 35 percent than if it returned to 39.6 percent.[20]   To be sure, the limit could be set below 28 percent to raise more revenue, but that would raise taxes on upper-middle-income filers with incomes in the 28 percent tax bracket (or create a cliff at $250,000 that would require a phase-in).

In short, despite its strong merits, this proposal isn’t an adequate substitute for allowing the high-income tax-rate reductions to expire.  Given the dimensions of the nation’s fiscal challenges and projected levels of long-term deficits and debt, the revenues that such a measure can raise should supplement, not substitute for, the revenues from allowing the high-end Bush tax cuts to lapse.

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