The Wall Street Journal
By: John D. McKinnon & Nick Timiraos
November 12, 2010
Proposed Elimination of Deductions, Investment Breaks Aims to Lift Tax Revenue
A presidential panel's draft overhaul of the tax system could hit higher earners hard, largely by wiping out deductions and investment breaks that tend to especially benefit those who make enough money to itemize their taxes.
The deficit commission has taken aim at one of the sacred cows of the tax code: the mortgage-interest deduction. Nick Timiraos discusses proposed changes and Brett Arends looks at the likelihood they will actually become law.
Those deductions and investment breaks, such as mortgage interest and lower tax rates for capital gains, increase after-tax income for the top 20% of earners--roughly, households earning more than $117,000--by more than 10%, according to data supplied by a White House-sponsored deficit panel that drafted the plan. That is compared to a 6% to 8% benefit for lower earners.
Higher earners could stand to recoup some of that loss through several other proposed changes, notably lower marginal income-tax rates. The plan, released Wednesday by the leaders of a White House commission assigned to tackle the nation's budget deficit, would cap the top tax rate as low as 23%, down from the current top rates of 33% and 35%.
To be sure, the wealthiest homeowners could be better off, even if the mortgage-interest deduction were eliminated, presuming they have cash to pay off a mortgage. They would then reap the benefits of lower tax rates.
Mailing in tax returns April 15 at the James A. Farley Post Office in New York. A draft proposal from the deficit panel would make major tax changes.
.But the draft proposal recommends overall that taxes go up by $751 billion by 2020.
An alternative overhaul scenario proposed in the draft plan would cap the top personal-tax rate at 28% and preserve many of the deductions and breaks, particularly those that benefit lower- and middle-income people, such as the earned-income tax credit and certain health and retirement tax breaks. The 28% top rate is the same one used during the Reagan administration in the 1980s after its overhaul of the U.S. tax system.
The new plan also would simplify the current system, collapsing six tax brackets into three and lowering the bottom rates to 8% in one version, from the current 10% and 15%.
The plan, described by tax experts as one of the most sweeping official proposals in memory, is intended to be a starting point for negotiations, according to commission aides. It is almost certain to be heavily modified before it becomes an official recommendation of the panel, if it ever does.
Still, the proposed plan is a lesson in how taxes could change in coming years, as lawmakers try to address the federal government's chronic high budget deficits.
The plan's most basic element is the elimination of so-called tax expenditures, the accumulation of deductions, credits and other tax benefits that Congress has adopted over the years for individuals as well as companies. The commission draft uses the sizable savings from this--tax expenditures as a whole cost the government more than $1 trillion a year in revenue--to offset the cost of lowering rates. These proposed changes are projected to result in a net $80 billion or so a year that could be applied to deficit reduction.
Tax expenditures include the deductions for mortgage interest, charitable deductions and state and local taxes, the exclusion of employer-provided health care from household income, and the lower tax rates that now exist for capital gains and dividends. Tax expenditures also include benefits that many lower-income people depend on, such as the earned-income tax credit, which supplements incomes for the working poor.
The political hurdles involved in eliminating many of these tax expenditures would be big.
The real-estate industry, for example, has repeatedly fended off efforts to curb the mortgage-interest deduction. But critics see an opening now because the housing bust has raised new questions about government support for home ownership. "There is an increasing understanding that single-family housing has been over-subsidized, and that's to the detriment of the broader economy," said Mark Zandi, chief economist at Moody's Analytics.
.Many economists have long argued that the deduction doesn't actually have a significant impact on homeownership and that it instead encourages higher-income borrowers to take on more debt. That's because the deduction is only available to people who itemize deductions on their tax returns, and low-income borrowers often fare better by taking the standard deduction instead of itemizing.
Certain aspects of the deduction move in the opposite direction from "long-run sustainable homeownership," said Thomas Lawler, a housing economist in Leesburg, Va., because borrowers who take equity out of their homes can receive a bigger deduction.
Realtors, home builders and mortgage bankers say that removing government support for housing will put downward pressure on home prices at a time when the housing market can ill afford it.
Mr. Zandi said any proposal could be phased in over time to avoid disrupting depressed housing markets.
Write to John D. McKinnon at email@example.com and Nick Timiraos at firstname.lastname@example.org