Obama’s Cap on Tax Deductions: Not What It Seems

By :: September 13th, 2011

It turns out that President Obama’s plan to limit the benefit of itemized deductions is much more than that. Not only would it reduce tax savings for mortgages, charitable gifts, high medical costs, and the like, it would also curb tax breaks for owners of municipal bonds, workers who buy health insurance, and those who earn money overseas. 

The $400 billion plan is the centerpiece of Obama’s $467 billion package of tax increases aimed at paying for the stimulus package he announced on Sept. 8. It would limit to 28 percent the value of many tax preferences for those whose adjusted gross income is more than $200,000 ($250,000 for couples). Today, these tax breaks are worth 35 cents on the dollar for someone in the top tax bracket. Under Obama’s plan they would be worth just 28 cents.  

The plan is often described as a cap on itemized deductions but in fact aims at a number of other politically popular tax breaks as well, including several exclusions that reduce the amount of income subject to tax.        

An across-the-board cap on the benefit of deductions and the like is often seen as rough justice—a way to tackle the Revenue Code’s trillion dollars in tax expenditures without  fighting over each one. The theory: It is an easier political lift to curb such popular breaks as the mortgage interest deduction through a broad reduction of  all subsidies than to fight the powerful housing industry head-on.

But Obama does pick and choose the preferences he wants to target. He nails all itemized deductions, all right, but he also goes after some--but not all--above the line deductions. Of the roughly two dozen write-offs available to those who take the standard deduction, Obama targets just eight, including health insurance for the self-employed, medical savings accounts, health savings accounts, and some higher education expenses.

He also reduces the benefit of two other hot-button breaks—the tax exclusions for municipal bond interest and the value of employer-sponsored health insurance. In other words, for those making more than $200,000, some muni bond interest and some of the value of their medical coverage would be taxed.     

However, Obama would protect other exclusions, including those for retirement savings. Picking winners and losers this way is likely to defeat any claims of rough justice and make passing the plan that much tougher.

And on the merits, some of his choices are dubious. For instance, nearly all mainstream economists believe Congress should fix the tax treatment of health insurance costs. Today, the income tax exclusion perversely gives the biggest benefit to those who make the most money and the smallest to those who earn the least and need the most help paying for insurance.

Obama could have proposed a tax credit that would boost the insurance subsidy for low-wage workers while cutting it for those at the top of the food chain. But he didn’t do that. He’d still protect the big fat subsidy for those making up to $200,000 but give no extra help to those who really struggle to pay their insurance premiums (I guess they’re supposed to use their new payroll tax cut).

That’s just one odd choice among many. The President deserves props for finally laying out the specifics of a tax plan. But now that I see them, I wish he’d made some different choices.     

 

9Comments

  1. Michael Bindner  ::  3:52 pm on September 13th, 2011:

    This proposal is mainly a way to embarrass Republicans. It is a campaign ploy, not a serious proposal. The way to finance this is to sell federal mortgage assets that are underwater to the Federal Reserve for the values of the underlying assets. The value loss has already occurred. It is time to realize it on the books and use the proceeds to stimulate the economy. The Fed would then tell servicers to write down the loans and adjust payments – reducing M2 while unlocking household spending. It would be a win-win.

  2. denim  ::  4:39 pm on September 13th, 2011:

    In the crafting of economic justice for all, one really cannot succeed by suspending the golden rule of civilized societies the world over.

  3. Ralph H  ::  6:28 pm on September 13th, 2011:

    Now we see what the real purpose of this plan is; to sneak in a tax cut for the “people” and to raise taxes on the “wealthy”, all while calling the bill a “jobs” plan. I have a few points.

    1. By cutting taxes and defering the increases until 3013 we will be faced with a whoper of an increase conveniently after the election, almost guaranteeing a recession (certainly with the Bush tax cutsw expiring).

    2. Except for the infrastructure projects there is little that will “create” jobs. For example I will “gain” about 25K in company and personal SSI savings and probably will save it for my retirement, or pay down debt on musiness loans. Don’t get me wrong, I’ll be happy to get the money but is it worth paying higher taxes forever?

    3. The President (and also Congress) have done NOTHING to address the major problem the economy faces —- labor competition from overseas which reduces the workforce that can be effectively employed in US and depresses wages. This puts the biggest pressure on the lowest skilled people and produces unemployment rates above 20% in the most vulnerable (inner city non HS graduates). I would think we have to increase consumption taxes and subsidize or increase labor intensive jobs to compensate.

    4. Mr Obama shows his lack of practical work experience and overall business knowledge in his plans. He hangs with academics and CEOs like Jeff Imelt (who has very effectively steered GE into paying no US taxes. BTW, I’m available and so are a number of small business owners!

  4. Len  ::  11:21 pm on September 13th, 2011:

    Starting in 2014, ACA would provide large subsidies for low-income people who get health insurance through exchanges (assuming it’s not repealed), so it’s not clear that additional low-income subsidies are warranted. I think he should repeal the ESI exclusion altogether and make the exchange subsidies available to everyone who gets qualifying health insurance whether through an exchange or at work (even at large firms, which won’t qualify under current rules).

  5. Michael Bindner  ::  4:08 pm on September 14th, 2011:

    I would rather see a VAT-like Net Business Receipts Tax to replace the corporate income tax, low rate income taxation not replaced by a VAT (to fund domestic discretionary military and civil spending), business taxes collected through the indiviudal tax code, the HI and DI payroll taxes and the portion of the SI payroll tax which goes to non-retirees. The NBRT would have an expanded refundable Child Tax Credit ($500 per month per child) and the ESI for those still offering private insurance or insurance through exchanges (since individuals making under $50,000 and families under $100,000 would no longer file under my proposal). The ESI should also be supplemented for employers who cover care for firms who offer coverage for retirees to opt out of Medicare and Medicaid long term care, provided that this coverage is superior. Do that and you might actually get some cost savings.

  6. Michael Bindner  ::  4:17 pm on September 14th, 2011:

    A $20 – $40 a week increase for most workers won’t be noticed enough to impact the economy.

    Tax increases on the upper 20% of earners will be noticed, but it will impact savings. Tax increases on the top 5% will take away the incentives for management to fund dividends and CEO bonuses by pursuing “productivity gains” such as holding back on wages and benefits, busting unions and sending jobs overseas. Overseas jobs are not from competition, but from these measures and cutting taxes on the rich make these measures attractive for management on the margins.

    The tax cuts in the plan won’t impact spending and while consumption taxes will help with foreign competition, their real benefit is that they are also a tax on profit as well as the wages of workers who provide products and services.

    The real thing holding down household spending is depressed housing values – especially when depressed below the loans used to purchase those assets. Arrest the decline in value by forgiving the loan value under water – either through bankruptcy reform or by writing down loans when the US holds the asset – and people who need to spend the most will be able to and those who are afraid to spend will begin spending as well.

  7. AMTbuff  ::  7:37 pm on September 14th, 2011:

    >However, Obama would protect other exclusions, including those for retirement savings.

    Retirement savings breaks are deferrals, not exclusions. The government gets its full cut from the money. The government actually profits from this tax break provided that the investments grow faster than the US government bond rate.

    Dropping this deferral would give the government a one-time acceleration of tax receipts. The government would spend the money now without making any provision for the shortfall in future revenues, not to mention the greater need for income support to retirees once their accounts have been cut down by taxes.

    We have already tried this experiment, in 1983 with Social Security. The government spent the extra tax money without diminishing the obligations that are now coming due.

    Obama was wise to omit this tax break from his hit list.

  8. Vivian Darkbloom  ::  1:55 am on September 15th, 2011:

    “The government actually profits from this tax break provided that the investments grow faster than the US government bond rate.”

    Exactly. With the additional advantage that the government can increase its “cut” by merely raising tax rates (A process we are likely now undertaking). What other kind of “investment” can you think of where one party (the government) has the right at will and unilaterally to increase its investment cut vis a vis the other investors even on accrued profits?

    We would, of course, need to make the exception here for “Roth IRA’s” but these constitute a small part of the retirement savings. And, to prove the point in the prior paragraph, most investors are now being advised to convert conventional plans to Roth IRA’s in order, among other things, to prevent the government from increasing its cut on those savings.

  9. Ralph H  ::  8:49 am on September 16th, 2011:

    Disagree on the impact of $20 to $40. My workers are basic lower middle class and primarily budget, spend and plan on a cash basis, and live week (paycheck) to week. They are very good at managing this and will adjust (up or down) to changes in their paycheck. My point is that probably 90% of a tax saving in withholding will hit the economy in a week. They are very good at adjusting their lifestyle to inflow, and do not get in trouble on credit card or other debt. For this type person (and throughout the country there are a lot of them) this type “stimulus” works. Me, I’ll save the cash.