During the 2012 presidential campaign, the Democratic party and the Obama campaign had one major criticism of Mitt Romney’s tax proposal: It couldn’t raise as much revenue from closing loopholes and limiting tax deductions for the rich as Romney claimed, so in order to achieve the rate reductions he promised it would have to raise taxes on the middle class. During the fiscal-cliff battle, the White House and Democrats made the same accusation: House Republicans couldn’t raise as much revenue as the White House wanted ($800 billion to $1 trillion, give or take) by closing loopholes — at least not without hitting the middle class.
The Senate’s budget proposes raising $975 billion over the next ten years, “eliminating loopholes and cutting unfair and inefficient spending in the tax code for the wealthiest Americans and biggest corporations” while ensuring that the tax increases “come only from the wealthiest Americans and biggest corporations.” (I’ll assume that means all Americans making less than $250,000, as both parties seem to have agreed that above that, there be tycoons.)
But there is almost no such thing as a tax benefit exclusively devoted to “the wealthiest Americans and the biggest corporations.” If you add them all together — the capital-gains rate paid on some investment managers’ compensation, or “carried interest” ($13 billion over ten years); mortgage-interest deductions for second homes and yachts ($80 billion over ten years, much of which comes from people making less than $250,000 anyway); accelerated depreciation for corporate jets ($2 billion over ten years); and a few others — you still end up with a paltry amount of revenue.
The Senate can propose to close loopholes that exclusively benefit the wealthy, and they can propose tax hikes that raise lots of new revenue — but they’re not the same thing.
Our tax system certainly does allow wealthy Americans to reduce their tax liability more than middle-class Americans can, but that’s because the former pay more in taxes, at higher rates. There are deductions that benefit high-income earners in particular quite generously — the mortgage-interest tax deduction, municipal-bond exemptions, state-and-local-tax deductions, retirement-savings preferences — but these don’t apply only to wealthy Americans, and they’re so popular that no recent presidential campaign or proposed congressional budget has suggested eliminating them entirely.
The realistic way to raise revenue via deductions is by diminishing the extent to which wealthy Americans can reduce their tax liability broadly, rather than by eliminating specific deductions. The Senate’s document acknowledges this and suggests three ways it can be done. Unfortunately, none of these options can conceivably raise $975 billion from Americans making more than $250,000.
One of the Senate’s ideas, reducing the value of itemized deductions high-income Americans can take to 28 percent (that is, each $100 in deductions could reduce a tax bill by no more than $28, even for a taxpayer who pays the top federal rate of 39.6 percent), has already appeared in some of the president’s budgets. The Tax Policy Center estimated that a 28 percent deduction cap would raise $288 billion over ten years if all of the Bush tax cuts expired, and just $164 billion if they were all extended — since they expired for income over $400,000, call it $200-odd billion, or not even a quarter of what the Senate budget needs.
The president’s budget proposal last year had a more aggressive version of this, which would have gone beyond limiting itemized deductions and taxed wealthy Americans on many things that are traditionally tax exempt, such as health insurance and retirement savings. The White House estimates that this would raise $584 billion, a little over half of what the Senate needs (the true number would actually be a bit lower, because tax rates haven’t been increased as much as the Obama budget assumed).
Another possibility, floated by Mitt Romney during the 2012 campaign, is a cap on the dollar value of itemized deductions. This could raise even more than the revenue needed — a $25,000 cap would mean $1.2 trillion more in taxes over the next ten years, but more than 30 percent of that would come from people making under $250,000. If you eliminate the cap for everyone below that threshold, and then adjust it so that people earning just over $250,000 don’t face a huge cliff, the total is down to $650 billion according to the White House’s own estimate.
The last option is a cap on tax preferences as a percentage of income. Harvard economics professor Martin Feldstein has been floating such an idea for a while now, proposing that all tax expenditures and the exemption for health insurance be limited to 2 percent of taxpayers’ incomes. That raises $2.1 trillion over the next ten years, but most of it comes from the middle class. Limit it to those making over $250,000, and you get only about $550 billion.
None of these estimates, by the way, would preserve the existing incentives for charitable giving. If a taxpayer can hit his deduction limit through his normal spending habits — his mortgage, state taxes, and so on — the charity deduction will no longer be a reason to give. Most politicians say they would like to preserve this incentive, but exempting charitable giving reduces the above estimates by up to one-third.
To sum up this issue, I would quote a White House statement, from economic advisers Gene Sperling and Jason Furman:
Plausible tax expenditure limitations that protect middle-class families and incentives to give to charity would raise far less revenue from the well off than is needed for a major budget agreement. A budget framework that raises only these amounts from high-income tax deductions while committing to no rate increases on high-income Americans would inevitably force any tax reform designed to further reduce the deficit to raise taxes on middle-class families simply to preserve lower rates for the most fortunate.
Their statement (about a Republican fiscal-cliff offer) happens to describe the Senate’s efforts quite well: Democrats would like a “major budget agreement” that largely preserves rapid growth in entitlement and discretionary spending, and the amount of revenue necessary to do that cannot be raised solely from eliminating deductions for high-income earners.
There is little to be gained from limiting deductions or loopholes for corporations, too. The U.S.’s corporate tax simply does not raise much revenue, and the ordinary deductions Democrats would like to take back from oil companies and companies that expand production overseas amount to little revenue. In theory, one could curtail the value of tax benefits, such as those for research and development and depreciation, for “the largest corporations,” but this has never really been proposed.
According to reports last week, President Obama has decided to take a different tack than the Senate: Rather than conjuring up $975 billion in fanciful revenue, his budget, to be released on Wednesday, aims to raise significantly less in taxes, and does so in at least two ways that hit the middle class.
The main chunk of revenue will come from the 28 percent limit I described above, though it’s not clear how much that will raise or exactly what it’ll cover. Then, $100 billion of revenue will be raised from adopting chained CPI, an inflation measurement that rises less slowly than the normal Consumer Price Index, which means that more people will be bumped into higher tax brackets. According to a 2011 analysis by the Tax Policy Center, in 2021, 77 percent of that new revenue would come from Americans making less than $250,000. The president has also proposed funding his pre-K-education proposal with an increase in cigarette taxes, levies that especially burden the middle class and the poor. (The Center for American Progress estimates the project would require $98 billion over the next ten years.)
One other proposal in the president’s budget aptly demonstrates how little revenue can be generated from trying to curb tax benefits for the wealthy: The administration proposes to cap the balance of tax-deferred and tax-exempt retirement accounts at $3 million (anything more than that makes ordinary retirement accounts an abusive loophole, the thinking goes). That will raise the grand sum of $9 billion over the next ten years — while still being quite disruptive for the investment industry.
Some new revenue can come from limiting tax expenditures, and if taxes must be raised, this is not a bad way to do it. But funding our current spending trajectory will require more than such a strategy can feasibly gather, meaning the money will have to come from one (or more) of three places: the middle class, new forms of taxation such as a carbon tax, or politically prohibitive and costly rates on the rich. Discussions of taxes and spending tend to ignore these facts, and Senate Democrats have now committed that ignorance to paper. President Obama has done only a bit better.
— Patrick Brennan is a William F. Buckley Fellow at the National Review Institute.