In an interview with News Bureau business and law reporter Phil Ciciora, Richard L. Kaplan, a law professor and expert on taxation and retirement issues, discusses Republican presidential candidate Mitt Romney’s proposal to place a $17,000 cap on income tax deductions, a change that would effectively reduce many popular tax breaks, including deductions for home mortgage interest and charitable donations.
Is a $17,000 cap on income tax deductions a good idea?
First of all, what ultimately gets enacted would likely be very different than what either candidate proposes in the debates or on the campaign stump. With that in mind, for a presumptive President Romney, one alternative to a fixed cap on income tax deductions would be lowering deductions by a percentage of income. It’s the same basic idea but it would have less of a negative impact on upper-income people, who would be hit the hardest by a fixed dollar cap.
In this hypothetical scenario, wouldn’t it be a better deal for the average American, since Romney has vowed to reduce income taxes by 20 percent across the board?
The lower tax rates that are the centerpiece of this proposal necessarily reduce the value of any deduction claimed, but reducing the amount of the deductions themselves is, in effect, a double whammy.
Lower tax rates may generally be less distortionary, but will people really respond differently if their tax rate is 20 percent rather than 25 percent, or 12 percent instead of 15 percent? Even at the top, is 28 percent versus 35 percent likely to seriously alter people’s inclination to work, save and invest?
The housing sector is one of the main drivers of the economy. How would limiting itemized deductions such as the mortgage-interest deduction affect homeowners?
A cap on itemized deductions would affect many people who took out home mortgages years ago on the assumption that their interest expense would be fully tax-deductible.
One option is to grandfather them in – that is, they get to deduct all of the interest on any mortgages obtained before some date. That approach is difficult to administer, since we would then have two sets of parallel rules for as long as those pre-enactment mortgages are around. Plus, the revenue lost from allowing those interest deductions to remain will translate into smaller tax rate reductions or larger budget deficits.
Another option is no special treatment at all. Most affected homeowners would consider this response to be changing the rules in midstream and therefore unfair, which would not engender much faith in government or encourage people to act on future tax incentives. Some may no longer be able to afford their existing mortgage payments and might have to sell their homes – if they can.
What about those who donate to charity?
Folks who donate to charities in anticipation of deducting their donations would find when they file their tax returns that a portion of their donation is not actually deducted – another change that could likely annoy taxpayers and further engender distrust of government.
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