Can Congress Raise Taxes on the Rich without Raising Their Rates? Maybe

By :: November 15th, 2012

At his press conference yesterday, President Obama said it is nearly impossible to raise taxes on the wealthy (a key piece of his fiscal strategy) without increasing their tax rates. It is, Obama said, a matter of simple arithmetic.  

But a look at some very rough numbers suggests that if the president and congressional Republicans want to compromise, there is a middle-ground. It may not be great tax policy and the politics is by no means easy, but the math may work.

To see how, first think about the two problems policymakers face--getting beyond the next few months and designing a long-term deficit reduction plan that includes both new taxes and significant reductions in planned spending.

Most of the current focus is on avoiding the fiscal cliff. Obama insists on extending most of the 2001-2003 tax cuts except for those that benefit the rich. Most Republicans want to extend those tax cuts for everyone, including the wealthy, which would add about another $1 trillion to the deficit. Their argument is what to do about the difference.

In Obama’s words, “It’s very difficult to see how you make up that trillion dollars…just by closing loopholes and deductions.”

Actually, it isn’t.

First, remember that both Obama and Mitt Romney proposed across-the-board limits on tax preferences.  

Obama would limit the value of deductions and some exclusions to 28 percent (thus, people in higher brackets would lose some of the benefit of their deductions). Such a cap would generate about $600 billion—if rates return to 2001 levels.

Romney would have placed a dollar cap on deductions. The Tax Policy Center figures that limiting deductions to $50,000 would generate about $750 billion. That’s probably high since it applies to all taxpayers, not just those who meet Obama’s definition of high income ($200,000 for singles/ $250,000 for couples). While most of the revenue from the cap would come from the higest-income taxpayers, some new taxes would be paid by those making less than $200,000. 

In addition, if Congress caps deductions for only the rich, it would need to phase-in such a change to avoid slamming someone with a big tax hike as soon as their income goes from $199,999 to $200,000. And that would reduce revenue even more.   

Where would the rest of the money come from? There are lots of options. Congress could set a deduction cap at $25,000 or $35,000 for high-income households instead of $50,000 (a $25,000 cap on all taxpayers could raise about $1.2 trillion, TPC figures). It could limit other big tax preferences for the wealthy, such as the exclusion for contributions to retirement plans.  Or their rates on capital gains could be raised to, say, 25 percent.  

Finally, there is a middle ground on those ordinary income rates. Obama would let the top rate revert to 39.6 percent. Republicans would keep it at 35 percent. What if they split the difference and settled on, say, 37 percent?

That would reduce the need for additional tax revenue, but would also shrink the amount of money that could be raised by a deduction cap, relative to a top rates of 39.6 percent. But on net it might make the task a bit easier.   

The politics of this would still be very tough. For instance, a deduction cap would hammer charities and they are already gearing up to fight it. TPC estimates that revenues would be cut by one-third if charitable gifts are excluded from a $50,000 deduction cap.

I’m not even sure these changes would get lawmakers all the way there. But they show a compromise is possible. There are ways, crude as they are, to hike taxes on the wealthy without raising their rates as much as Obama would like.

Still, there is another important issue to keep in mind. A cap would only fill the hole left by preserving the low rates now enjoyed by the wealthy. Thus, revenues from such deduction limits would no longer be available to help reduce the long-term deficit—a job that would then be more heavily weighted to spending cuts. And that may be the real reason why Obama is reluctant to use this tool in the short run.

10Comments

  1. TaxVox » Blog Archive » Can Congress Raise Taxes on the Rich … « Double Taxes  ::  6:45 pm on November 15th, 2012:

    […] posted here: TaxVox » Blog Archive » Can Congress Raise Taxes on the Rich … Comments […]

  2. Michael Bindner  ::  9:19 am on November 16th, 2012:

    I suspect that staffs have quietly been working on long term rate tax reform language to abandon capital gains and dividend special rates while lowering the top rates to somewhere between 25% and 31%. The interim phase in measure could likely be a 25% capital gains and dividend rate and a reduction of the top rate to a 10% surtax on the next higher rate of 33% (which would be 36.3%). Where you start reducing and increasing depends on your baseline – pre or post December 31st. I expect Republicans to geek because Obama has all the cards in his deck. He always has, which is why it is possible that this whole drama has been choreographed long in advance.

  3. AMTfan  ::  8:12 am on November 17th, 2012:

    Howard: why is the AMT ignored when claims are made that increasing tax rates for the top 2% will result in more revenue? I am fortunate to be in that tax bracket and by my calculation will not pay a penny more in federal income tax under the proposed Obama model because of the AMT – the tax code simply does not apply to me – I fill out the two page AMT form and have a hefty tax bill – that wont change if my rates are increased by 5% – it would take a 10% rate increase to outpace my AMT tax burden. And all the while the politicians must realize this – or do they?

  4. Fiscal Cliff Investment Strategies from John Navin & Associates John Navin  ::  8:04 pm on November 20th, 2012:

    […] Both parties actually have a lot of common ground in the fiscal cliff debate. Neither side favors a sequester – federal spending cuts, an un-patched AMT, or Medicare cuts for doctors.  Both sides want to address American’s debt by raising revenue and reducing expenditures. The major point on which the parties disagree is a familiar one: taxes. Democrats have called for increasing taxes on upper-income earners, a move which Republicans have opposed. However, newly chastened Republican lawmakers appear to be willing to allow higher tax revenues in the form of eliminated deductions for high-income earners, but no tax increases. Democrats appear to be willing to consider a compromise that would limit or eliminate deductions as well as set the top income tax rate above the current 35% level, but below 39.6%4. […]

  5. Undertax  ::  1:14 am on November 21st, 2012:

    What is your thought on pressure being put on housing prices? If people are limited on mortgage deduction, won’t it also limit the amount of mortgage someone can take on. To allow for this loss of buying power, will home values fall and by how much?

  6. richard  ::  8:53 pm on November 21st, 2012:

    How does ESI get impacted by the cap on deductions? Is the ESI included in the cap on deductions revenue figures or would setting a cap on ESI generate additional revenue?

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