Former Reagan Economic Adviser Suggests Capping Deductions

March 25, 2013

All sorts of ideas are floating to the top during the almighty 2013 Battle of the Federal Budget. Republicans want to accomplish a balanced budget and reduction of the federal deficit through spending cuts exclusively, while Democrats want propose a combination of new revenues (i.e., tax increases, although without increasing the marginal tax rates) and spending cuts.

Smiling Benjamin Franklin portrait on a dollar bill.Now Martin Feldstein, professor of economics at HarvardUniversity, president emeritus of the nonprofit National Bureau of Economic Research, and formerly the chairman of the Council of Economic Advisers to President Ronald Reagan, is weighing in with his opinion in the Washington Post. Surprisingly, his suggestions may be the perfect compromise: for the Republicans, they are considered spending cuts, because they are technically a reduction of “tax expenditures,” or government spending accomplished via the tax code; and at the same time, for the Democrats they are revenue increases, as they essentially raise the amount of income tax that is being collected.

What Feldstein is suggesting is that current subsidies or deductions can be tightened up and even in some cases eliminated, to reduce the loss of billions of dollars in tax revenues to certain taxpayers.

Many Small Deductions

There are many small deductions given to small groups of people, such as homeowners who install energy-efficient appliances or new insulation in their homes.  While these are actions that the government should be encouraging residents to adopt, in the interest of environmental preservation, these may not be actions that we as a country in economic crisis can afford to subsidize at the moment.

Large Popular Deductions

The bigger and more popular deductions include the mortgage interest on a homeowner’s primary residence, employer-paid health insurance, and the deductions for state and local taxes. Feldstein does not propose eliminating these subsidies, as they are extremely well-liked and would possibly be political suicide for any legislator truly attempting to get rid of them.  However, he suggests a cap on the amount of these deductions, which would potentially be more palatable to the taxpaying public.

Don’t Touch Charitable Contributions

Feldstein argues for retaining the full deduction for charitable contributions, since the benefits of the contributions do not accrue to the taxpayer, but to the organization which receives the contributions. Since these organizations help the country as a whole, the deduction should stand as it currently exists.

Capping Deductions as a Percentage of Income

Under Feldstein’s proposal, all deductions would remain, but a maximum deduction would apply. He specifies a figure of 2% of AGI; all deductions would be calculated and totaled, and then the actual amount deducted would be reduced (if necessary) to 2% of AGI.

Feldstein’s plan applies to all taxpayers, not simply those making over $250k. Under his proposal, a taxpayer with AGI of $75,000 would find his deductions reduced to $1,500. A taxpayer with $250,000 in AGI would have his itemized deductions limited to $5,000.

Feldstein doesn’t refer specifically to the Standard Deduction in his article, but presumably it would have to be reduced as well in order to adhere to the 2% cap. Considering that the standard deduction is currently $11,900 for every taxpayer, this represents a staggering reduction for almost every level of income, but the lowest earners would clearly be hit the hardest.

Feldstein asserts that this plan would generate $140 billion in additional revenue in 2013, and that if applied over the next decade, it would result in deficit reduction of $210 trillion. And he suggests that with that large of a reduction, it would even be possible to lower the marginal income tax rates.

Compared to Current Proposals

The president’s current proposal, which involves limiting deductions mainly on households with over $200k in income, would generate only $21 billion in 2013 and only $300 billion over ten years.

Feldstein asserts that his plan raises six times the revenue, while placing less of the burden on high-income taxpayers. “Any serious plan to reduce government spending that is built into tax law should raise more revenue and call on most taxpayers to participate.”

Feldstein’s proposal certainly raises more revenue and/or cuts more spending, depending on how you view it. But who will be paying those extra taxes, or receiving that reduced spending?

Regardless of what legislators decide ultimately, your best bet is to make sure that you keep current on all tax regulations.
If you are unsure, you can consult a professional tax preparer in Los Angeles and be certain you are getting all of the deductions to which you are entitled, and reducing your tax liability to the absolute lowest that is legally permitted.