The Mielke Way: What About Those Deductions?
Dr. David Mielke, Retired Dean of the College of Business at EMU
The Republican tax reform framework is attracting the expected criticism from the Democrats, but the bigger question is whether or not the Republicans can find common ground to pass reform that many expect will grow the economy. The Republicans are already showing signs that the elimination of all individual tax deductions except mortgage interest and charitable contributions will face pressure and may kill the legislation before it gets started. In particular the elimination of state and local deductions for property, income and sales taxes faces stiff opposition. Overlooked in the focus on these tax deductions are the deductions for medical expenses. Will the continuation of these deductions dilute tax reform and compromise expected economic growth? Will this issue kill reform and lead to the fallback position of just reducing tax brackets and lowering tax rates? Or will this lead to killing all hopes of any tax deal and thereby also kill the corporate tax reform because the plan now is to package individual and corporate tax reform together in one bill? Should these deductions be eliminated? What is the “Right Thing to do?” Let’s look at some issues:
- The only way to lower tax rates for individuals and corporations without exploding the debt is to eliminate deductions and loopholes which amounted to a record $1.6 trillion last year. Picking and choosing among those to be eliminated, capped or retained creates winners and losers.
- By eliminating the special treatment for state and local taxes, the federal government will save more than $1.25 trillion over 10 years. This savings and the $1.5 trillion the Republicans have agreed to in their budget negotiations will pay for the lowered corporate and individual tax rates.
- The deductions are a classic example of tax preferences that add to the complexity of the code and subsidize some Americans at the expense of others. The prime beneficiaries are six states that take nearly half of the savings, costing nearly $100 billion a year in lost tax revenues.
- Looking closer, the deductions tend to benefit the wealthiest people living in the most affluent areas, especially in California, New York, New Jersey and Connecticut. Nearly 9 of 10 filers in earning more than $500,000 a year itemize and take advantage of these deductions. As an example, in Manhattan the average deduction is $24,000, in San Francisco it tops $15,000.
- Some 88% of the benefits in 2014 flowed to households earning more than $100,000, according to Congresses’s Joint Committee on Taxation. According to the Tax Foundation, only 1% went to filers who earn less than $50,000. Some 45 million filers deducted more than $550 billion in these taxes in 2015.
- No other loophole would save as much money, including mortgage interest. Saving $1.25 trillion would finance a 10 point cut in the corporate tax rate.
- 35 Republicans serve in for blue states, New York, New Jersey, California and Illinois, where the state and local deduction is used by a significant number of taxpayers. Democrats are expected to target them in the 2018 election should the deductions be eliminated.
- As it stands now, taxpayers can only deduct any unreimbursed medical expenses that exceed 10% of their adjusted gross income. More than 9 million Americans deducted roughly $87 billion in medical expenses on tax returns in 2015, according to IRS data.
- The upshot is that taxpayers who do qualify for medical deductions are often facing serious and costly health issues requiring services or treatments not covered by insurance.
- Economists point to a large body of research showing that tax loopholes drive inefficient economic activity, slower economic growth and a lower standard of living for all residents.
- Republicans point to the increase in the standard deduction from $12,000 to $24,000 for a married couple as an offset to the loss of deductions for the vast majority of taxpayers and the tax simplification, ending the need to itemize deductions.
Democrats are criticizing the tax reform outline as usual, by stating it benefits the wealthy. It is difficult to understand, if they want to tax the rich more, why the plan to eliminate these deductions wouldn’t accomplish this? Do they actually oppose raising taxes on the rich? Would the elimination for the state and local tax deductions make it more difficult to pass tax increases and increase spending in some states? If the GOP can’t kill the entire state and local tax deductions, should they cap them or have an income level at which they could not be deducted to protect low and middle income taxpayers? Should the medical deduction be eliminated? What is the “Right Thing to do?” It is time to actually reform both the individual and corporate tax laws—that means eliminating all deductions other than mortgage interest and charitable deductions. A level playing field for all taxpayers means eliminating the state and local tax deductions that do in fact benefit essentially six states and the wealthiest taxpayers. The Republicans have to actively push for the elimination those deductions—framing the Democrats as favoring the wealthy by fighting for maintaining them. The increase in the standard deduction and the lower tax rates will certainly shield the majority of Americans who currently itemize those deductions and actually result in lower taxes overall—not to mention simplifying their returns. Watering down those deductions by merely capping them will not provide the savings necessary to take full advantage of expected economic growth. There should be a way to help those middle income taxpayers who have very high medical expenses by having an income maximum to use the deductions. The overall impact of continuing these deductions for some people will not have a dramatic effect on the tax plan. However, is the elimination of those deductions really feasible? My opinion, they will not be eliminated, perhaps only capped which will kill tax reform and with it the corporate tax reform that is so badly needed. That is why there should be 2 tax reform bills, corporate and individual. As it stands now, the success of any tax reform and tax relief is all about those deductions.