ONE OF the larger tax increases that Congress adopted to reduce the deficit will in effect tax the deductions of upper-income households; their deductions will be curtailed by an amount equal to 3 percent of adjusted gross income in excess of $100,000. The step was derided as a back-door rate increase, a way of raising the top income tax rate another percentage point without seeming to, and thereby of saving face for and compromising with the president who had said an increase from 28 to 31 percent rate was as high as he would go.
The proposal was indeed such a compromise, but it is more than that; it is good tax policy. The familiar mortgage interest, charitable contribution, state and local tax and other federal income tax deductions can best be thought of as tax expenditures. They have the same effect as if the government didn't allow them, collected the tax they save, then turned around and gave the same money back out to the same households in the form of spending. The idea is fine: that there are certain expenditures, as for housing or state and local government services, that the federal government either wants to support or doesn't want to count as taxable income and penalize.
But in a progressive system these deductions (and the familiar exclusions from income, employer-paid health insurance premiums, for example) have a perverse effect. The higher a family's income, the higher its tax rate, the larger its likely deductions (and exclusions) and the larger its federal subsidy. A high-income family in an exclusive neighborhood gets a larger federal housing subsidy than a lower-income family in a lesser part of town. To limit deductions thus makes good social sense. It broadens the tax base progressively and avoids the behavior-distorting effects of higher rates.
There are various ways to impose such limits. In theory the best might be to weigh the merits of each deduction (or exclusion) separately; in political fact it is probably easier to adopt a single broad limit for all. A limit can take the form of a steady toll as income rises or of an absolute cap (no deduction for more than a certain amount of mortgage or mortgage interest, for example), and each will have a different effect.
The inventive proposal that Congress adopted (by Rep. Don Pease of the House Ways and Means Committee) is in the former category. It sets a threshold for deductions rather than a ceiling; there is therefore no loss of incentive to give the extra dollar to charity, nor loss of cushioning effect if a state or local government imposes an extra dollar of tax. It's a way of reducing the loss from these traditional tax expenditures without taking the edge off them. That's a step in a useful direction, good fiscal policy in present circumstances, and good tax and social policy as well.