Romney Just Quietly Announced a Good Tax Policy Idea

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By Josh Barro

Mitt Romney has been talking vaguely, for months, about expanding the federal income tax base, but in an interview yesterday with Denver's local Fox affiliate he got a lot more specific. The Republican presidential nominee floated the idea of capping itemized deductions at $17,000 per filer.

ABC News reports:

"As an option you could say everybody's going to get up to a $17,000 deduction; and you could use your charitable deduction, your home mortgage deduction, or others – your healthcare deduction. And you can fill that bucket, if you will, that $17,000 bucket that way," he said during a visit with Denver's FOX31. "And higher income people might have a lower number."

A few thoughts on this:

1. This is a good idea, and I wish Romney had announced it sooner. Almost every itemized deduction in the income tax code is a bad idea, and this policy would significantly reduce the value of such deductions.

2. This proposal helps to show why the complaint that 47 percent of households pay no federal income tax is a red herring. Romney's plan would greatly expand the income tax base without at all reducing the number of filers whose liability is $0. Mostly it would operate by raising the taxable income of people near the top of the income scale -- because that's where the money is.

3. Because this is a specific idea, it should be easy to score. I expect the Tax Policy Center will run the numbers soon and estimate how much revenue it would generate.

4. This proposal gives Romney a concrete response to the Obama campaign attack that he wants to raise taxes on the middle class. This policy would hold almost every taxpayer making less than $200,000 a year harmless from tax increases.If tax rates are cut by 20 percent across the board, as Romney also proposes, you would have to face a 25 percent increase in your taxable income to get hit with a tax increase.*

For example, that means a family with $150,000 in income would have to be taking $43,600 in itemized deductions today in order to get hit with a tax increase -- not impossible, but unlikely. (And many of those high-deduction filers get hit with the Alternative Minimum Tax today, which Romney says he would repeal.)*

*Update: An astute reader points out that I neglected the effect of graduated income tax rates in doing this calculation. A married couple with no kids making $150,000 a year would break even on Romney's proposal if they currently take $35,728 in itemized deductions, not $43,600. With an income of $60,000 a year, the break-even would come if the couple currently takes deductions of $22,920.

How generous this makes Romney's proposal depends crucially on how he treats health benefits. Currently, employer-provided health benefits are excluded from income and not even reported on the tax return. If Romney is not including that health exclusion under his $17,000 cap, then it will be rare for middle-income filers to see a tax increase. But many middle income families earn a large fraction of their income in health benefits and could see tax increases if he is including them.

This is something the Romney campaign should flesh out. Romney also did not address whether the $17,000 cap is adjusted for filing status. If married couples get a substantially higher allotment than singles, that could adjust for the health care issue.

5. There are some details that should be fleshed out. Particularly, many tax preferences do not take the form of deductions, but of credits or exclusions. Tax-exempt interest, health benefits and retirement contributions are excluded from gross income instead of deducted. "Above the line" deductions taken on page 1 of the Form 1040, such as for moving expenses, are also not generally subjected to limitations on itemized deductions.

In order to determine how much money this plan would raise, we need to know whether a wide variety of tax preferences would be impacted, or only below-the-line deductions. I hope Romney will indicate that his plan also hits tax exclusions, as that would raise a lot more revenue and do more to eliminate distortions in the tax code.

6. Any plan that keeps Romney's promises on cutting rates 20 percent and holding the middle class harmless has to sacrifice revenue neutrality, and I expect this plan will fall far short of raising the roughly $5 trillion over 10 years that is needed to offset Romney's tax rate cuts.

7. Romney nods toward not just capping itemized deductions but phasing them out, saying that rich people might be limited to even less than $17,000 in itemized deductions. I have no enthusiasm for this proposal, because a phaseout of deductions is equivalent to an increase in marginal tax rates.

Suppose that for every $100 in extra income you earn, you lose $10 worth of deductions, meaning that your taxable income rises by $110. If your nominal marginal tax rate is 30 percent, you pay an extra $33 in taxes -- meaning that your effective marginal tax rate on that $100 of income is 33 percent, not 30 percent.

If the point of limiting deductions is to help keep tax rates low, then a phaseout that raises effective marginal tax rates is self-defeating. If Romney wants to collect more revenue from high earners, he'd be better off proposing a higher top marginal tax rate than a deduction phaseout.

8. I continue to be annoyed that Romney committed to a 20 percent reduction in tax rates. The key problem with the U.S. tax code is not that rates are too high, but that projected budget deficits are too large and the politically palatable ways to raise revenue (such as high income surcharges and higher capital gains tax rates) are especially economically damaging. Base broadening is needed as a better way to shrink the deficit -- linking it to rate cuts that are likely to more than offset the broadening leaves us without good long-term budget solutions.

(Josh Barro is lead writer for the Ticker. E-mail him and follow him on Twitter.)

Read more breaking commentary from Josh Barro and other Bloomberg View columnists and editors at the Ticker.

-0- Oct/03/2012 15:45 GMT