Business Ethos Blog

Closing Loopholes to Avoid the Fiscal Cliff

It appears that the major sticking point for a compromise to increase tax revenues is how to do it.  The Republicans suggest closing tax loopholes and possibly reducing deductions.  President Obama wants to raise tax rates on the so-called “millionaires and billionaires”, which translates to anyone earning $250,000 or more.  I am still not sure of how this fuzzy math is calculated.  The question is, what is the “Right Thing to do” to find a compromise to avoid the cliff?  Before we look at some issues, I think it is important that people understand the dire situation we face in terms of deficit spending and the national debt.

One of the difficulties in understanding the budget situation is that talk of billions and trillions is difficult for anyone to grasp.  I propose that we do a simple exercise to bring the discussion to numbers we can all understand.  To do this, I have removed 8 zeros from the billions and trillions.  The result is this scenario:

1. Annual family income, $21,700

2. Money the family spent, $38,200

3. New debt on the credit card, $16,500

4. Outstanding balance on the credit card, $142,710

5. Total budget cuts so far, $38.50

Given this simplified example, it seems obvious that the “Right Thing to do” is to cut spending.  Instead however, the President’s emphasis is on raising the income.

Mitt Romney suggested during the campaign that one way to raise revenues and to avoid increasing tax rates would be to limit deductions—there have been suggestions to limit the deductions from $17,000 to $50,000.  Since high income people are more likely to itemize deductions, this would meet Obama’s desired objective of taxing the rich.  The initial reaction to this novel idea was very positive—even President Obama seemed to be interested.  This move would have the effect of not favoring one deduction over another and allow taxpayer choice as to how they would use deductions such as for mortgage interest, charitable contributions and state and local income and property taxes.  Why have we not heard about this during the fiscal cliff discussions?

Here are some issues:

1. Income tax deductions for state and local taxes totaled $250 billion in 2010.  Of this total 5 liberal states, California, New York, New Jersey, Maryland and Massachusetts accounted for $122 billion—California $51 billion alone.  These are the states with the highest state income, local and property taxes in the country.  Limiting these deductions would hit these taxpayers the hardest.  Those states that have low or no state income, local and property taxes, for example Texas and Florida averaged deductions of $100 and $219 respectively. Taxpayers across the country are subsidizing the high tax states.  When California raised its income taxes to a top rate of 13.3% last month, they were voting to reduce their federal income taxes and thus increased the pressure to increase federal taxes on all Americans.

2. Currently, employees do not pay taxes on the employer or their personal contributions for health care plans.  Taxing these benefits would raise $150 billion.

3. Eliminating the mortgage deduction would increase revenues by $90 billion.

4. Lobbying has already begun to protect the charitable and mortgage interest deductions.

What is the “Right Thing to do?”  Limiting deductions to raise revenues and to avoid tax rate increases continues to be a good solution—this should include limiting the tax free health care.  It is no wonder that Chuck Schumer of New York and Nancy Pelosi of California have been avoiding limiting tax deductions—they are protecting the unfair federal tax deductions for their high tax states.