The Obama campaign and the press corps keep demanding that Mitt Romney specify which tax deductions he’d eliminate, but the Republican has already proposed more tax-reform specificity than any candidate in memory. To wit, he’s proposed a dollar limit on deductions for each tax filer.
During the first Presidential debate, Mr. Romney put it this way: “What are the various ways we could bring down deductions, for instance? One way, for instance, would be to have a single number. Make up a number—$25,000, $50,000. Anybody can have deductions up to that amount. And then that number disappears for high-income people. That’s one way one could do it.”
In an October 1 interview with a Denver TV station, Mr. Romney mentioned a cap of $17,000 and said “higher income people might have a lower number.” His campaign stresses that these dollar amounts are “just illustrative” and that there are other ways to reduce deductions that in any case would have to be negotiated with Congress.
But details aside, the tax cap is a big idea, and potentially a very good one. The proposal makes economic sense to the extent that it helps to pay for lower marginal tax rates. Lower rates with fewer deductions improve the incentive for investing and taking risks based on the best return on capital rather than favoring one kind of investment (say, housing) over another. This would help economic growth.
The idea may be even better politically. 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.
Another benefit is that the Romney deduction cap would cost taxpayers more in states with the highest tax burdens. Think of California, Illinois, New Jersey and New York.
The current tax code allows filers to deduct state income tax, real-estate tax, and some sales taxes from federal tax. This rewards states for raising taxes. Under the Romney cap, many upper-middle-class filers wouldn’t be able to write off all their state taxes. This would create political pressure to cut state taxes.
We realize the tax cap isn’t perfect and carries some risks. The tax code would not become any simpler. Liberals would also pocket the limits on deductions for the wealthy and immediately try to raise rates again. But that political risk exists for any reform short of repealing the 16th Amendment. Our preference would be to eliminate all such deductions and lower rates as far as possible, but we shouldn’t make a perfect reform the enemy of the much better.
By the way, Mr. Obama has also called for limiting tax deductions for high-income filers. His budgets have endorsed allowing them to take writeoffs at a rate of 28% instead of 35%. The big difference is that Mr. Romney wants to dedicate the revenue gain from capping deductions to cutting tax rates. Mr. Obama wants to use the money to pay for more spending.
The larger point is that Mr. Romney is serious about reform and has put on the table a serious idea for how to finance and achieve it. That’s far more than Mr. Obama has proposed about anything in a second term.