The editors of the Wall Street Journal wrote Romney’s Tax Deduction Cap- An idea to finance reform and avoid political trench warfare. 10/19/12
The historic challenge for tax reformers is defeating the most powerful lobbies in Washington that exist to preserve their special tax privileges. Among the biggest is the housing lobby that exists to preserve the mortgage-interest deduction—the Realtors, home builders, mortgage brokers and the whole Fannie Mae FNMA -0.73% gang.
But don’t forget the life insurance lobby (which benefits from the tax exclusion on the equity buildup in policies), the tax-free municipal bond interest lobby, the charitable deduction lobby and more. Each one will fight to the death to preserve its carve-out, which means that reformers have to engage in political trench warfare to succeed.
This is one reason President Obama wants Mr. Romney to be more specific: The minute he proposed to limit the mortgage-interest deduction, the housing lobby would do the Obama campaign’s bidding by running ads against Mr. Romney’s plan. Mr. Romney is right not to fall for this sucker play.
By limiting the amount of deductions that any individual tax filer can take, Mr. Romney is avoiding this lobby-by-lobby warfare. He’d let individual taxpayers decide which deductions they want to take up to the limit. In effect, the deductions would compete with one another as taxpayers decided which one was most important to them.
The political left should have a hard time opposing this because reducing deductions would hit high-income taxpayers the hardest. Out of the 140 million tax returns in 2009, the last year such data are available, only 45 million itemized their deductions. The non-itemizers, who take the standard deduction ($11,900 for joint filers in 2012), would be held harmless by the Romney cap. Most of these are lower- or middle-income earners.
The nearby table shows that the dollar value of deductions rises with incomes. Filers who itemized and earned between $10,000 and $40,000 in 2009 had average itemized deductions of roughly $16,000. This means they would on average lose nothing under a Romney cap. The average deduction amount rose to about $22,000 for incomes between $75,000 and $100,000. Filers with $1 million in income had average deductions near $173,000, and those who earn $10 million or more had deductions of about $4.3 million.
The genius in Romney’s plan is in NOT being specific. If he enumerates the deductions he risks the wrath of special interests. By simply limiting the deductions in total he forces the deductions to compete, including the state income tax deductions. Much of the lobbying activity is about preserving tax deductions.
By offsetting much of the loss of deductions with lower tax rates we increase the incentive to grow. It is the marginal tax rates, the additional tax on the next dollar of income that most affects the desire to earn more. By lowering the marginal tax rates, additional earnings and the tax revenue it generates is encouraged. This requires that Congress give up its penchant for social tinkering and the courting of lobbyists.