Scrapping deductions instead of raising rates

at 10:06 AM ET, 11/03/2011


(Steven Senne/AP)
If Congress decides to raise taxes to close the deficit, how should it go about it? Mark Thoma sends us to Richard Green, a professor at the University of Southern California’s Marshall School of Business, who argues that paring back deductions in the tax code would be far more economically efficient than raising tax rates:

If my mortgage interest deduction goes away, for example, my federal tax liability would increase by around 10 percent; alternatively, the federal government could just charge me a 10 percent surtax on income.
If my income is taxed, the impact on my desire to work is ambiguous. ... If you take away my mortgage interest deduction, however, the impact is not ambiguous—I will have an incentive to work more. Leisure is no less expensive (there is no substitution effect), but my desire to restore my previous income remains as before.

As we’ve noted before, there's a lot of money involved in deductions. Len Burman and Marvin Phaup have found that total U.S. tax expenditures ran to about $1.2 trillion in fiscal year 2011, about as much as all discretionary spending. The mortgage-interest deduction alone added $104.5 billion to the deficit, about the same as the Bush tax cuts will cost next year.

But don’t these tax credits largely benefit the middle class? Isn’t that why they’re so enormously popular? Over at the Monkey Cage, Suzanne Mettler has been posting graphs trying to debunk this claim. The vast majority of the benefits, she notes, are claimed by upper-income Americans:

As she notes: “In 2004, families with incomes of $100,000 or above—the top 15 percent of the income distribution—claimed 69 percent of the benefits of the home mortgage interest deduction, and 55 and 30 percent of the tax benefits associated with employer-provided retirement benefits and health benefits, respectively.”

There’s some evidence that Mettler’s view is catching on with the broader public. A recent Bloomberg poll found that 48 percent of Americans were willing to scrap all tax deductions in exchange for lower overall rates for all tax brackets. And various tax commissions have proposed phasing out some of these credits. The Bowles-Simpson Commission, for instance, proposed replacing the mortgage-interest deduction with a 12 percent annual credit and limiting it to first homes and mortgages under $500,000. (Presumably policymakers would want to take this slow, so as not to push home prices down further right now.) At the moment, however, there aren’t many signs that Congress is eager to take this up.

Update: I originally neglected to give the excellent Mark Thoma credit for the links. Apologies for the error!

 
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