Why It's Hard to Pay for Trump's Tax Cuts
President Donald Trump made what seemed like a bold proposal in the latest iteration of his tax plan: To help pay for deep rate cuts, he would do away with most of the deductions that millions of Americans claim every year. On closer examination, though, that pledge looks a lot less impressive.
In principle, scrapping various deductions and loopholes is a great idea. They cost hundreds of billions of dollars, complicate the tax code, often create perverse incentives, and tend to benefit the wealthy. Any responsible reform would have to address them in some way.
One crucial question, though, is whether the tax breaks that Trump targets will generate enough savings to cover the cost -- estimated at more than $6 trillion over 10 years -- of what he wants to do, which is slash rates to 35 percent for top individual earners and 15 percent for corporations and pass-through businesses. 1 If they don't yield enough savings, his plan will boost budget deficits in a way that economists doubt would be offset by faster growth.
So what is he targeting, and how much is it worth? Given the lack of detail, any answer inevitably involves some guesswork. For the first part of this analysis, let’s assume that when Trump's advisers say "tax breaks," they mean the itemized deductions that people claim on their returns (we're in good company here). Here's a very rough estimate 2 of the value of those deductions over the next decade, in a world where rates are already at Trump's desired level:
One conclusion is that Trump is leaving a lot on the table. Although his plan claims to eliminate "tax breaks that mainly benefit the wealthy," it protects two of the biggest: The deductions for mortgage interest and charitable giving. Together, based on these estimates, they would cost $1.5 trillion over the 10-year period. One item Trump officials have singled out is the deduction for state and local taxes -- which could save $1.1 trillion. Killing all the others, including unreimbursed business expenses, medical expenses and gambling losses, would increase that only to $1.6 trillion.
Even if Trump changed his mind and went after all itemized deductions, he'd fall short -- and not just because they don’t add up to anything near $6 trillion. Most viable proposals aimed at the mortgage-interest deduction, for example, would modify rather than eliminate it. One such idea -- replacing the deduction with a credit worth 15 percent of interest payments, limited to loans of $500,000 or less -- would save about $100 billion over the first 10 years.
For bigger savings, Trump would have to venture into the politically fraught territory of so-called above-the-line tax breaks, the various benefits that get excluded from income before anyone starts itemizing deductions. These include employer-provided health insurance, contributions to retirement savings accounts and the "step-up basis," which zeroes out capital gains at death. Here's an estimate -- again, very rough -- of what some of the largest could be worth over a decade:
Based on the latest information from the White House, Trump doesn’t intend to touch retirement savings. Simply adding the cost of health insurance to income would gobsmack people and businesses with sharply higher income and payroll taxes, and would surely face vehement opposition in Congress. More palatable proposals, designed to tailor the tax preference toward the people who need it most, would save something closer to $400 billion or less over 10 years.
In short, paying for tax cuts as deep as the ones Trump is proposing won’t be easy. Unless he wants to go back to the drawing board and try something completely different, he'll probably have to curb his ambition.
From 39.6 percent for top earners, 35 percent for corporations and a 39.6 percent maximum rate for pass-through income.
As a starting point, I used the Treasury Department's latest report on the cost of various deductions and other tax expenditures. I also used Internal Revenue Service records to estimate the size of deductions not included in the Treasury report.
The Treasury's estimates are based on current tax rates, so they had to be adjusted to account for the lower tax rates in Trump's plan, which would reduce the value of the deductions. To that end, I used the Tax Policy Center's estimates of marginal tax rates, focusing on the top quintile of taxpayers to account (at least partially) for the fact that the breaks accrue predominantly to people in higher tax brackets. The relevant rate under the Trump plan was 27.9 percent, compared with 31.1 percent under current law. So I multiplied the Treasury estimates by 0.90 (27.9 divided by 31.1). Hat tip to New York University professor David Kamin, from whom I borrowed this method. I take full responsibility for any errors.
At least three factors might skew the results:
- Treasury's estimates don't include behavioral responses: If, for example, employer-provided medical insurance were taxed, employers might provide less of it, reducing the revenue gained by eliminating the preference.
- If more high-earning individuals set up as pass-through corporations to take advantage of the proposed 15-percent rate, the value of deductions would also be lower.
- The Tax Policy Center calculated effective marginal rates when Trump was proposing brackets of 12 percent, 25 percent and 33 percent. The latest proposal lowers the first bracket to 10 percent and increases the last bracket to 35 percent, which on net would make deductions a bit more valuable.
To contact the author of this story:
Mark Whitehouse at email@example.com
To contact the editor responsible for this story:
James Greiff at firstname.lastname@example.org