A funny thing happened on the way to the tax debate: We started talking about "math," rather than policy. And just because something works on a calculator doesn't mean it will work as law.
The White House has been saying that "the math" precludes replacing the revenue from the Bush tax cuts for the rich with tax reform that holds rates steady. As we've pointed out, that's not technically true: You could raise as much as $1.2 trillion from people making more than $200,000 by eliminating all their deductions.
On Thursday, Gene Sperling and Jason Furman, the director and deputy director of President Obama's National Economics Council, laid out their math (which was obtained earlier by The Washington Post). The basic argument isn't that "the math" makes that kind of tax deal impossible; it's that the reality of tax policy makes that kind of tax deal impossible, for three reasons:
- Limiting the cap to those with incomes over $250,000 leaves only $800 billion in revenue. A $25,000 cap that applied to all households would raise taxes by an average of $2,400 on 17 million households with incomes below $250,000 ($200,000 for singles). Treasury estimates show that about 40 percent of the revenue from such a cap would come from these households. Thus, the amount of revenue that could be raised from taxpayers making more than $250,000 is only about $800 billion.
- The need to phase in a cap to avoid a “cliff” reduces revenues to around $650 billion. In practice, it would not be possible to impose a $25,000 cap on itemized deductions beginning at an income threshold of $250,000. Doing so would create an immense “cliff,” where someone whose income rose to $251,000 could suddenly owe thousands of dollars more in taxes. Accounting for a realistic phase-in reduces the revenue from households above $250,000 by about 20 percent, to about $650 billion.
- Excluding the charitable deduction reduces revenues to around $450 billion. With a $25,000 itemized deduction cap, 97 percent of households in the top 1 percent of income would lose any tax incentive for additional charitable giving (they would also lose a very large share of the state and local tax deduction). The loss of the charitable deduction would be expected to reduce giving by these households by at least $10 billion per year under the Congressional Budget Office’s assumptions. The Tax Policy Center (TPC) estimates that exempting the charitable deduction reduces the revenue available from caps on itemized deductions by about 30 percent, with a similar reduction in the revenue raised from high-income households. This reduces the total revenue from a $25,000 cap to about $450 billion.
The White House is right: We're not going to replace all the income from letting the Bush tax cuts for the rich expire with tax reform. We might replace some of it -- and the White House is signaling they're open to that -- but not all of it. The likeliest outcome of the tax talks is a hybrid approach that combines an increase in marginal tax rates with a cap in deductions. That would leave the top rate higher than it is now, but lower than it would be if the Bush tax cuts simply expired.