Close to $1T could be raised by limiting deductions; hey, it's a start
It seems inevitable that the deal to resolve the fiscal cliff will involve a tax increase on the highest earners. As my colleague Deborah Solomon pointed out this month, that may create an accidental legacy for Mitt Romney: A proposal he threw out off the cuff during the presidential campaign to limit itemized deductions is a plausible compromise that would raise revenue without raising tax rates.
This idea has since come under unwarranted fire, from the outgoing Senate Budget chairman, Democrat Kent Conrad, Treasury Secretary Timothy Geithner and my Bloomberg Businessweek colleague Peter Coy. The refrain is that a limit on deductions simply can't raise enough revenue without excessively hitting the middle class.
This is wrong and reflects, I think, a hangover from the campaign. It's true that, contrary to Romney's promises, base broadening could not raise nearly enough to offset $5 trillion in other tax cuts over 10 years, unless you soaked the middle class. But we're not looking for nearly that much revenue today -- it is possible to get hundreds of billions of dollars, or even more than a trillion, from a progressive cap on itemized deductions.
President Barack Obama has asked for $1.6 trillion in added revenue over a 10-year window as part of a larger fiscal-adjustment deal. We are not doing the full fiscal adjustment this year; what we get as part of the fiscal cliff negotiations will just be a fraction of that as a down payment.
As the Tax Policy Center has shown, base broadening can raise a lot of revenue while making the tax code more progressive. Capping itemized deductions at $25,000 a filer would raise $1.3 trillion over 10 years relative to current policy; a $50,000 cap would raise $749 billion. If you exclude charitable deductions (likely a political necessity; they are currently excluded from the Alternative Minimum Tax calculation) the figures would be $885 billion and $490 billion, respectively.
Nearly all the new revenue would come from the top. Tax filers in the top quintile of earners (those making over $112,000) would pay 86 percent of new taxes with a $25,000 cap and 96 percent with a $50,000 cap.
Or look at it this way. A $25,000 deduction cap would mean that the average middle-quintile family (one making between $43,000 and $68,000 a year) would pay $110 in additional taxes, for a tax rate increase of 0.2 percentage points. The typical filer in the top 0.1 percent (making over $3.3 million) would pay an added $253,000, for a tax rate increase of 2.5 percentage points.
This policy does not hold the middle class completely harmless, but pledging to do so was always silly. Trying to raise taxes on only the top 2 percent means tying yourself in knots; for example, if you won't raise taxes on a taxpayer who makes $248,000, you can only get a little bit of revenue out of one who makes $260,000.
And if government services are so valuable, we should be willing to ask earners throughout the top half of the distribution to pay more for them -- especially if we're going to ask them for smaller percentage increases than those at the top.
The final fiscal adjustment deal, which I do not expect to come before 2015, likely will require raising the top rate above 35 percent. But there is no particular reason to do that this year, as part of the down payment of new revenue that will precede the larger deal.
A tax increase that raises revenue mostly from the rich ought to be appealing to liberals, and the fact that it would be less economically damaging than tax rate increases should be a bonus. But many on the left seem to have come to view a higher top tax rate as an end in itself, rather than just another progressive way to raise revenue. They are angry about the Bush tax cuts and want to see their most regressive part undone. Those emotions are standing in the way of a good deal.
(Josh Barro is lead writer for the Ticker. The opinions expressed are his own.)
