Common Sense: A Popular, but Not Quite Fair, Tax Proposal

Mr. Romney’s proposal to limit itemized deductions to a fixed dollar amount, which surfaced during the campaign as a way to close loopholes for the wealthy and broaden the tax base, has attracted a surprising amount of bipartisan support, given its origins in conservative Republican circles.

“There’s renewed interest” in the cap on deductions, Senator Kent Conrad, the North Dakota Democrat who heads the Senate Budget Committee, told The Times last month as budget negotiations heated up.

The political appeal of a proposal that limits deductions without actually naming any — inciting the powerful interests and lobbyists that support them — seems obvious. But many tax experts said that a fixed dollar cap is anything but the evenhanded approach to closing loopholes it appears to be.

Moreover, without addressing larger tax preferences, like a lower rate on capital gains, it does almost nothing to cure the so-called Buffett problem, in which Warren Buffett’s secretary pays a higher effective rate than her billionaire boss. It doesn’t even raise much revenue.

Some tax experts have gone so far as to say it’s a conservative Trojan horse, a stealth tactic that protects the very wealthy while targeting Democrats who itemize deductions and live disproportionately in high-tax states like New York and California. It would also affect donors who support elite colleges, universities, museums — even experimental theater — which are perceived as havens for liberals.

And it would hit people like me: taxpayers in higher brackets who rely on earned income as opposed to investment income or an inheritance, who give to charity and live in a high-tax state. Assuming a $35,000 limit on itemized deductions, my federal tax last year would have risen to 27 percent of my adjusted gross income, from 22 percent.

I wouldn’t mind paying more as long as people who make vastly more did, too. But limiting the itemized deductions of the top 400 taxpayers with an average adjusted gross income of $202 million in 2009 (the most recent year available) would have raised their taxable income by an average of $32 million and their average rate to 25 percent from 20 percent, assuming a marginal rate of 35 percent, and even less if they pay a lower marginal rate, as most do.

That’s a lower rate than I paid, because nearly half their income, on average, was from capital gains.

Martin Feldstein, a Harvard economist and the chairman of the Council of Economic Advisers under President Reagan, is widely credited with the idea for an across-the-board cap on itemized deductions as a way to help lower the deficit. His proposal last year called for capping deductions at 2 percent of adjusted gross income.

Mr. Romney embraced the concept, but proposed a fixed dollar cap as low as $17,000 rather than a percentage. Since then, the idea has been embraced by politicians from both parties and the centrist research organization Third Way.

(The proposed cap on deductions shouldn’t be confused with President Obama’s proposed 28 percent cap on the rate at which deductions can be claimed by high-income taxpayers.)

Despite its bipartisan support and seemingly neutral approach, it didn’t take long for the nonprofit sector to figure out that a fixed dollar cap on itemized deductions is a stake aimed at the heart of the charitable deduction. That’s because of the three largest itemized deductions — state and local taxes, mortgage interest and charitable contributions — only charitable contributions are entirely discretionary.

People have to pay state and local taxes, and in high-tax states like New York, Massachusetts and California, that deduction alone would reach the cap and in many cases exceed it, depending on where it’s set. Many people require a mortgage to own their homes, and are contractually obligated to repay it.

Article source: http://www.nytimes.com/2012/12/15/business/plan-to-cap-deductions-is-setback-for-charities.html?partner=rss&emc=rss