Sunday, November 11, 2012

Taxes and the Fiscal Cliff

I'm planning a series of posts regarding the fiscal cliff, but Greg Mankiw recently posted a link to a study by the Tax Policy Center (joint project of the Urban Institute and Brookings Institution; both normally condiered center-left institutions) which examined the impact of limiting tax deductions.  For those who listened to the campaign closely, this was part of Mitt Romney's tax reform proposal (lower the tax rates and limit the deductions; he mentioned figures between $17,000 and $25,000).  For new readers of this blog, lower tax rates provide for a higher after-tax rate of return on working, investing, and saving, thus leading to more of each (how much of an impact is subject to some debate).  Given that Mitt Romeny lost, his tax reform proposal won't be implemented, but instead of allowing the Bush tax cuts to expire on those earning above $250,000 per year, taxes can be raised by limiting tax deductions.  One of the chief proponents of this approach is Martin Feldstein, chair of the Council of Economic Advisots for President Reagan.  He, and many other economists, refer to most tax deductions as tax expenditures.  Why?  the government can subsidize a certain activity by spending money on it or by allowing individuals to deduct it from their taxes (here are commentaries from Feldstein in the WSJ and NY Times).  So there's some agreement between those on the right and left about reducing tax expenditures (limiting tax deductions) as a way of achieving more government revenue.  According to the study, limiting tax deductions to $50,000 per year would raise over $700 billion over the next decade with 80% being paid by the top 1% (this assumes the Bush tax cuts are extended for all income levels, including those earning over $250,000).  Thus, President Obama could get his tax hike on the rich while Republicans can extends the Bush tax cuts and keep tax rates at their current level.