How Tax Reform Will Really Happen, Assuming It Happens

by Reihan Salam

Recently, I sketched some brief thoughts on how I’d like to see the tax reform debate play out. But that is very different from how I think it will actually play out in practice. Late last week, a friend reminded me of the reform strategy proposed by Martin Feldstein, Daniel Feenberg, and Maya MacGuineas:

This paper analyzes a new way of reducing the major individual tax expenditures: capping the total amount that tax expenditures as a whole can reduce each individual’s tax burden. More specifically, we examine the effect of limiting the total value of the tax reduction resulting from tax expenditures to two percent of the individual’s adjusted gross income. Each individual can benefit from the full range of tax expenditures but can receive tax reduction only up to 2 percent of his AGI. Simulations using the NBER TAXSIM model project that a 2 percent cap would raise $278 billion in 2011. The paper analyzes the revenue increases by AGI class. The 2 percent cap would also cause substantial simplification by inducing more than 35 million taxpayers to shift from itemizing their deductions to using the standard deduction. For any taxpayer for whom the 2 percent cap is binding, a cap would reduce the volume of wasteful spending and the associated deadweight loss. Even for those taxpayers for whom the cap is not binding but who are induced by the cap to shift from itemizing to using the standard deduction, the deadweight loss associated with deductible expenditures would be completely eliminated.

The genius of this strategy is that it does not target any particular constituency or interest group, like the real estate industry or people who live in high-tax jurisdictions. It’s not pretty, but it will do the job of raising revenue that can be used to either reduce the deficit or to lower rates.