How much revenue would a cap on itemized deductions raise?
Capping deductions would raise revenue in a highly progressive way but how much revenue and how progressive depend on the cap, Williams writes.
In last night’s debate, Mitt Romney repeated the idea that he could pay for much or all of the 20 percent rate reduction and other tax cuts in his tax plan by capping itemized deductions at $25,000. He had previously suggested a $17,000 cap in an interview and, in the first debate, $25,000 or $50,000 caps—and possibly phasing deductions out entirely for high-income taxpayers. Capping deductions would raise revenue in a highly progressive way but how much revenue and how progressive depend on the cap.
Itemized deductions disproportionately benefit high-income taxpayers for three reasons:
- High-income taxpayers are more likely to itemize deductions. Less than 10 percent of those in the bottom two income quintiles (fifths) itemized in 2011, compared with about 80 percent of those in the top quintile and more than 95 percent of those in the top 1 percent.
- High-income taxpayers claim more itemized deductions. Itemizers in the bottom two quintiles averaged less than $14,000 in 2011, compared with nearly $38,000 for those in the top quintile and more than $170,000 for the top 1 percent. A higher cap on deductions would therefore affect fewer taxpayers and a larger share of affected taxpayers would have very high incomes.
- A dollar’s worth of deductions reduces taxes more for high-income taxpayers. That dollar saves 35 cents for someone in the top 35 percent tax bracket but only 15 cents for a person in the 15 percent bracket.
As a result, more than 80 percent of the tax savings from itemized deductions in 2011 went to those in the top quintile and more than a quarter to the top 1 percent. Paring back those deductions would hit high-income taxpayers hardest.
To get a sense of how much money we could raise by capping tax deductions, my TPC colleagues have analyzed the resulting revenue gains and distributional impacts of four ways to limit itemized deductions—eliminating them entirely and capping them at $17,000, $25,000, or $50,000—calculated against three benchmarks (current law, current policy, and current policy with 20 percent lower rates and elimination of the AMT). As usual, the current law baseline has all expiring tax cuts actually expiring, while the current policy baseline has almost all of them permanently extended.
Eliminating all itemized deductions would yield about $2 trillion of additional revenue over ten years if we cut all rates by 20 percent and eliminate the AMT. Capping deductions would generate less additional revenue, and the higher the cap, the smaller the gain. Limiting deductions to $17,000 would increase revenues by nearly $1.7 trillion over ten years. A $25,000 cap would yield roughly $1.3 trillion and a $50,000 cap would raise only about $760 billion.
But higher caps would impose proportionally more of the tax increase on higher-income households, as new TPC estimates show. With tax rates 20 percent below today’s rates, about 83 percent of the revenue gain in 2015 from a $17,000 cap would fall on the top quintile and about 40 percent on the top 1 percent. Raising the cap to $25,000 would boost those shares to nearly 90 percent on the top quintile and fully half on the top 1 percent. A $50,000 cap would virtually exempt the bottom four quintiles from higher taxes: less than 4 percent of the tax increase would fall on them, while nearly 80 percent would hit the top 1 percent. (Phasing down the caps at high-income levels would, of course, concentrate the revenue gains even more at the high end, but how much would depend on the details.)
Suggesting limits on deductions was Governor Romney’s first public statement about how he might offset the revenue lost by cutting tax rates. Without more specifics, we can’t say how much revenue such limits would actually raise. But these new estimates suggest that Romney will need to do much more than capping itemized deductions to pay for the roughly $5 trillion in rate cuts and other tax benefits he has proposed.