Understanding TPC’s Analysis of Limiting Deductions
By Roberton Williams :: October 19th, 2012
The Tax Policy Center’s new tables showing the revenue and distributional effects of capping itemized deductions have received a great deal of attention since we released them on Tuesday. Our results show that capping deductions can raise a large amount of revenue in a quite progressive manner. Capping deductions could thus be an important component of any tax reform proposal that also wants to reduce tax rates.
However, specific aspects of our analysis have confused people. To reduce that confusion, let me make five points.
- The new tables do not analyze Mitt Romney’s tax plan. Governor Romney has not released a detailed tax plan, so it is not possible to analyze it fully. Nor has Romney articulated a specific proposal to cap tax deductions. In recent weeks, however, he has repeatedly mentioned capping deductions as a possible approach to offsetting the revenue losses from his proposed tax cuts. Other tax reformers have floated similar ideas. To get a sense of how much revenue such caps might raise—and how much of that revenue would come from households at different income levels—our tables examine four ways of limiting deductions: eliminating all of them or capping them at $17,000, $25,000, or $50,000.
The effects of such caps depend on the structure of the rest of the tax code, so we examined their impact in three different tax worlds—assuming all temporary tax cuts actually expire as scheduled (the current law baseline), assuming those temporary cuts are made permanent (current policy), and current policy with 20 percent rate cuts and no AMT. That third baseline reflects two major components of Romney’s known tax plan; the other baselines might apply to tax reforms that have different rate and AMT structures.
- The new revenue table shows the gross revenue gains from eliminating or capping deductions, not the net effect of limiting deductions and making the tax cuts proposed by Romney. In other words, the revenue estimates show the effect of capping deductions, but do not include any revenue changes that would occur moving from today’s tax rules to the tax rules in each particular baseline.
- The same is true of the new distribution tables: they show the gross effect of limiting deductions, not the net effect of limiting deductions and making other changes. In particular, the tables that use the third baseline (20 percent rate cut and AMT elimination) show the tax increases by income level from limiting deductions, but do not include any tax cuts from moving to that baseline. Where we show the average household would pay about $1,400 more if all deductions were repealed, for example, we are describing only that gross tax hike, but do not include any tax savings from an across-the-board rate cut or repeal of the alternative minimum tax. That’s why none of our tables show anyone getting a tax cut. Our goal was not to examine a specific tax plan but rather to inform the broader discussion of tax reform by showing how one possible component of reform—limiting deductions—would affect revenues and the taxes households pay.
- The third tax baseline— current policy with 20 percent rate cuts and no AMT—represents part but not all of Mitt Romney’s known tax plan. In particular, that baseline excludes making investment income tax-free for low- and middle-income households, allowing the Obama tax cuts to expire, and repealing the estate tax and taxes associated with the 2010 healthcare legislation. As a result, the estimated revenue gains from limiting deductions in that baseline are not exactly the amounts of revenue that could partially offset the revenue loss from Romney’s proposed tax cuts. We chose to model it this way because other people are working on tax reform proposals that would cut rates 20 percent and eliminate the AMT, but otherwise differ in their details from the known Romney plan.
- Elsewhere, TPC has analyzed the known elements of the Romney plan. In March, TPC estimated the distributional effects of the parts of the Romney plan that the campaign defined in detail. We labeled distributional tables from that analysis as “Romney Tax Plan without Unspecified Base Broadeners.” Because the campaign has not specified what those unspecified base broadeners would be, we have not updated that analysis.