Is It Feasible to Cut Tax Preferences to Pay for Lower Tax Rates?

 

I have been focusing lately on America’s two biggest fiscal and economic problems:

  • How to boost the economy in order to put more people back to work
  • How to either cut spending or raise revenue in order to shrink the deficit.

A few days ago in “The Great Wage Slowdown and How to Fix It,” I laid out a fairly specific proposal to make a substantial reduction in tax preferences in order to cut tax rates across the board and especially for the 64% of taxpayers who do not itemize deductions.  These are the middle- and lower-income workers with stagnant incomes who would likely spend any tax savings they received thereby giving the economy a big boost. Let’s examine whether or not this is a realistic course of action.
CaptureThe above chart from the Congressional Budget Office document, “The Distribution of Major Tax Expenditures in the Individual Income Tax System,” shows that, for example, the upper 10% of households by income receive about 40% of the total $1 trillion in individual tax expenditures per year.  Furthermore, this same top 10% of tax payers have an income of about $140,000 or more (Congressional Research Service). My basic idea is to shrink tax preferences by $250 billion per year and to lower tax rates for middle- and lower-income non-itemizers by this same amount.  If we assume that they would spend 2/3 of this new income, it would boost the economy by $170 billion per year which is 1% of GDP.
A reasonable way to achieve this savings is to expect higher income earners to contribute a greater percentage of their tax preference savings.  For example:

  • top 1% contribute $110 billion (2/3 of their total deductions).
  • top 96th % to 99th % contribute $50 billion (1/2 of their total deductions).
  • top 91st % to 95th % contribute $30 billion (1/3 of their total deductions).
  • top 81st % to 90th % contribute $30 billion (1/4 of their total deductions).
  • top 61st % to 80th % contribute $30 billion (1/5 of their total deductions).
  • this gives a total of $250 billion in tax preference savings.

This back-of-the-envelope calculation is not intended to be definitive but rather to suggest what can be done along these lines.  Those who are more well-off need to make bigger sacrifices in getting our economy back on track.

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