Tax deductions and magical thinking: When smart policy makes for unpopular politics

October 10, 2015

By Matthew E. Milliken
Oct. 10, 2015

Republican tax plans all seem to have something in common — something besides lowering the top individual and corporate income-tax rates, that is. See if you can spot it.

Real estate mogul and reality TV host Donald Trump’s tax plan aims to lower taxes and to simplify the tax code. Trump’s proposal claims that its “tax cuts are fully paid for by:”

1. Reducing or eliminating most deductions and loopholes available to the very rich.…

3. Reducing or eliminating corporate loopholes that cater to special interests, as well as deductions made unnecessary or redundant by the new lower tax rate on corporations and business income…

Former Florida Gov. Jeb Bush’s tax proposal would:

• Simplify the tax code for all Americans to lessen the power of the IRS and increase both prosperity and fairness.

• Reduce loopholes and special tax provisions created by lobbyists that invariably benefit those at the top.

Florida Sen. Marco Rubio’s 25-page plan asserts that:

By simplifying the structure of the tax code, this proposal will also reduce the burden of confusing choices and excessive paperwork. Most itemized deductions will be removed…

Kentucky Sen. Rand Paul’s proposal bears the blunt headline “Rand Paul’s Tax Plan Would Blow Up The Tax Code And Start Over.” Some highlights:

I would eliminate nearly every special-interest loophole.…

All deductions except for a mortgage and charities would be eliminated.

New Jersey Gov. Chris Christie’s strategy includes this nugget:

Governor Christie will reform the tax code by creating a flatter, fairer and simpler individual income tax system and keep returns simple by reducing deductions and giveaways.

Louisiana Gov. Bobby Jindal’s program, which is presented in tersely written sentences, would:

Eliminate the personal exemption, the standard deduction and all itemized deductions, except for five…

Did you spot the thing these proposals have in common? If you answered something along the lines of, “They all propose eliminating most if not all deductions,” then give yourself a gold star! Cutting deductions is a vital component of plans that reduce tax rates because it preserves some government revenue that would otherwise be lost.

Although I’m against the flat tax and other regressive schemes put forward by these (and countless other conservative-generated) tax reform strategies, I do agree that simplifying the tax code would be great, and there are definitely terrific arguments for cutting out a wide variety of deductions. However, I have a bone to pick with this specific plank in the plans of Mssrs. Trump, Bush, Rubio, Paul et al.

My caveat is simply this: Eliminating tax deductions and loopholes is a heavy lift. This shouldn’t come as a surprise to anybody, but exemptions that were put into the tax code by special interests and lobbyists did not appear by accident. Moreover, in most cases, as long as they hold real or perceived value for those industries, such exemptions won’t disappear without a fight.

Take the mortgage interest exemption. Many Americans love it: In a 2011 poll conducted by The New York Times and CBS, more than 90 percent of respondents said that it was either very or somewhat important that the federal government continue to let homeowners deduct interest paid on mortgages from their income tax burden (see question 41).

This is despite the fact, as CNBC editor Mark Koba wrote in 2013, that “only about 30 percent of taxpayers actually use the mortgage interest deduction each year. And the majority of those savings were taken by higher earners.”

The deduction’s popularity is ironic given the significant evidence that it has been found to be ineffective at encouraging home ownership, which many Americans think is the exemption’s purpose. Bruce Bartlett, a policy advisor to Presidents Ronald Reagan and George H.W. Bush who is now sharply critical of the Republican Party, wrote in 2013 that housing prices have increased to offset the benefit of the deduction. One study cited by Bartlett found that “many countries without deductibility have higher home ownership rates than we do, and some with deductibility have lower rates.”

And yet the deduction has some very deep-pocketed defenders. “We would fight it tooth and nail,” an official with the National Association of Home Builders told CNBC when asked about the prospect of a repeal. The organization typically spends $2 million to $4 million a year to influence Congress, according to the Center for Responsive Politics. The National Association of Realtors, which has spent at least $12 million annually on lobbying every year since 2006, calls the mortgage interest deduction “a remarkably effective tool that facilitates homeownership”; unsurprisingly, the group “opposes any changes that would limit or undermine current law.” As a whole, the real estate industry spends anywhere from $60 million to $95 million annually on lobbying, per the Center for Responsive Politics.

Tax lawyer Ian Shane told CNBC that he believes the mortgage interest deduction could be ramped down without hurting the housing market. “I don’t think it would slow down housing,” he said. “But I don’t think it will be easy. It’s so ingrained in the U.S. that people expect it.”

But the mortgage interest deduction isn’t even the largest tax exemption on the books. The numbers vary from year to year, but in 2014, it ranked just fifth, at $68 billion. (See table 1 on page 4 of this report from the Federation of American Scientists.) The top four exemptions last year were, in ascending order of value:

• The earned income tax credit, at a cost of $69 billion.

• Contributions to and earnings from retirement plans, $89 billion.

• Reduced tax rates on dividends and long-term capital gains, $96 billion.

• Exclusion of employer contributions for health care, $143 billion.

The earned income tax credit is considered one of the nation’s most valuable tools in the fight against poverty. The other three exemptions benefit middle-class, upper-middle-class and upper-class taxpayers. Any guesses on whether or not lobbyists on the right or the left would allow any of these deductions to expire quietly, regardless of whether or not it’s paired with a substantial tax cut?

It’s worth noting that the Affordable Care Act, more widely known as Obamacare, was designed to offset the deduction for employer contributions to health care. It does so, per CNBC’s Dan Mangan, by imposing “a 40 percent charge on the cost of employer-sponsored health plans that exceeds certain thresholds — $10,200 for individual coverage and $27,500 for family coverage, as of 2018.” (That’s when the provision is scheduled to take effect.)

Critics of this levy, which is often called the Cadillac tax because it targets premium health-care benefits, include the U.S. Chamber of Commerce and labor unions. The former organization has spent $444.2 million on lobbying in the past five years, an average of nearly $90 million per annum. Unions as a whole have spent more than $40 million annually on lobbying since 2007 and have given at least $60 million every two-year election cycle over the past 20 years.

(Most labor union political spending has gone to political action committees, thanks to campaign finance constraints, although it’s worth noting that (a) when it comes to direct contributions, unions favor Democrats by a wide margin, and (b) contributions to outside spending groups, also known as soft money, have skyrocketed ever since the Supreme Court’s 2010 ruling in the Citizens United case largely deregulated activity in this sector.)

Cutting deductions may sound like a great idea, and it frequently wins the approval of policy wonks, but it’s challenging to implement. That’s not a reason in and of itself to reject a given tax reform proposal — but it is a reason to be somewhat skeptical when evaluating what might happen when President Trump or President Whomever starts trying to implement his (or her) policies.

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