Income Tax: cut rates or deductions?

tax reformOn the personal side, we have protected the three big deductions — charitable, mortgage and retirement saving. We want to raise the standard deduction caps and get rid of many of the other personal deductions. —Gary Cohn

Income Tax: cut rates or deductions, which is best for the taxpayer? It depends.

If deductions are small relative to income, rate cuts are better. The savings are proportional to the rate–a one percent in rate gives a one percent reduction in tax due. The dollars saved depends on income–for a hundred thousand income a one percent rate cut saves a thousand; for a million dollar income a one percent rate cut saves ten thousand. Thus wealthy taxpayers generally benefit from rate cuts especially when marginal rates for the wealthy are high.

Taxpayers for whom deductions are significant benefit less than others from rate cuts–loss of deductions hurts. Low income taxpayers don’t qualify for many deductions and enjoy relatively low rates in any case. High income taxpayers who manage to offset most of their income with tax shelters may prefer high rates to loss of deductions; in extreme cases when taxable income is near zero due to tax avoidance, rates are unimportant.

Republicans generally favor rate cuts since they are the “party of the rich.”

What about specific deductions:

  • Charitable
  • Home mortgage interest
  • Retirement savings
  • Property, sales and/or income taxes

Charitable and Home mortgage interest are most useful to those who can afford expensive homes and generous gifts. Tax free retirement savings are useful to those who wish to shield income from taxes during working years. Property, sales and/or income taxes, which have been slated to be eliminated, may be at risk.

The problem with Property, sales and/or income tax deductions is that they benefit those in high tax blue states such as New York and California. Eliminating the property, sales and/or income tax deduction would hurt those states, but raise considerable revenue.

To protect NYS taxpayers, Tom Reed has proposed converting the current state income and/or sales tax deduction into a credit. The tax foundation suggests the credit might be 15 percent. This would be a win for taxpayers who enjoy a lower effective rate and a loss for those who currently pay more than 15 percent. While the tax foundation isn’t necessarily unbiased, the analysis of this proposal cited is interesting and useful.

Tom Reed’s proposal, while welcome, contrasts starkly with earlier proposals to embarrass NYS politicians by compelling a change in the way NYS funds medicaid. One might wonder which proposal better reflects Tom’s attitude toward his home state. Both proposals might perversely appeal to tax resisters.


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14 Responses to Income Tax: cut rates or deductions?

  1. Arthur Ahrens says:

    Before any discussion of tax modification takes place, a refresher in history is needed.

    The last major tax overhaul took place in 1986. A bipartisan consensus determined the need of a severe modification of the tax code. Reagan showed leadership throughout the process, which involved over two years of bipartisan discussion. Final votes in the Congress demonstrated this bipartisanship, with both Democrats and Republicans scoring wins and losses.

    Our recent history shows that Trump provides no leadership. We should expect none in the tax cuts to come. The Republicans are not interested in governing. They are interested in providing tax cuts to the 1%. They clearly demonstrated this in the ACA fight. The Democrats are an unempowered minority. No good faith gestures have been made towards bipartisanship.

    Given all of that, it’s obvious that the intent of any tax legislation coming from this Congress is to remove any residual wealth from anyone who is not in the 1% and funnel it to the 1%.

    Any discussion of rates or deductions is a waste of time.

    The real question is how badly will Tom Reed and his Republican accomplices skin us this time?

    And that will be answered in the fullness of time.

  2. whungerford says:

    Arthur, I am not nearly so pessimistic. Gary Cohn outlined the administration’s proposals; Congress will have other ideas. Republicans will probably find it difficult to reach consensus within the GOP, and so will have to seek votes from Democrats. Cohn may not keep his job; President Trump may undercut any progress with an ill-timed tweet.

    Congress can’t do too much for the wealthy without busting the budget. The proposed increase in the standard deduction is welcome. Proposals to remove business tax loopholes, while we may have reason for suspicion, are surely for the better.

    More good news: they seem not to be considering a flat income tax or a national sales tax. Some cause for concern: repeal of the AMT, estate tax repeal, weakening the principle of the progressive income tax. Another concern is inadequate revenue used as an excuse for budget cuts.

    If we expect our representatives to serve our interests, we had better keep watch on what they are doing.

  3. Anonymous says:

    I would be surprised if Gary Cohn doesn’t quit during the process. Trump will lose patience and lash out. He thinks everything is instant oatmeal, and Cohn has already expressed frustration with Trump’s behavior. The 15% business tax is just outright undoable, and Trump will throw a fit. Fasten your seatbelts.

  4. whungerford says:

    Yes, but if Cohn goes will there be an adult in the room at the whitehouse?

  5. Joseph Urban says:

    The tax code is where all the special interest groups and corporations get their pork. The only way to eliminate this is to develop a tax plan that eliminates all deductions over time. By all deductions I mean all of them. ALL of them. Do this over a 10 year period so businesses and individuals can adjust. No loopholes. None. Zero.
    Also eliminate the concept of “non-profits” avoiding taxes. Any individual or organization that brings in money from any source should be fairly taxed . Right now you and I are paying higher taxes because “not-for-profits” (some of which have CEOs making 6 or 7 figure salaries) go untaxed. Some of these “not-for-profits” are really political organizations who lobby Congress to change laws.I would phase out all of this tax avoidance over a 10 year period, as well.
    Finally, all income, from any source, should be taxed as earned income. This includes pay, investment income, inheritance, etc. And Social Security and Medicare/Medicaid taxes should be paid on all earned income as well. This would make SS solvent overnight.
    Of course these ideas have no chance of passing Congress which relies on the manipulation of the tax code to keep special interests happy.

    (Still banned by Askimet so I cannot use my wordpress account:

  6. whungerford says:

    Joseph, I can’t agree on taxing non-profits. What is it that they might be taxed on, gross income? Other organizations are taxed only on profit. Executive salaries? The executives pay taxes on those just as highly paid executives in for-profit businesses.

    I am also uneasy with the idea of eliminating all deductions. Certainly some serve a worthwhile purpose. I see that if any are allowed, there is a question of where to draw the line.

    I don’t understand your problem with Askimet; the link you gave works for me.

  7. Anonymous says:

    Taxing the NFL would also be sensible.

  8. Joseph Urban says:

    Bill. I think you put your finger on the reason why there will never be meaningful tax reform. It is the old question of: Whose ox gets sacrificed? Every business, every organization, etc. thinks that they should be the exception because they are providing a benefit that is essential. That is exactly the current problem with the tax code.
    First, I would not tax profits for corporations, I would tax gross income (but the rates, adjusted, would be significantly lower than today). And yes, I would tax any gross income from any organization that collects money.
    Why? That is the only way to end the manipulation of the tax code by the various deductions and loopholes. Eliminating all deductions would drive down the rate and end any manipulation.
    Why should a company be able to deduct the “cost of doing business” ? Does that not discourage efficiency? In other words, a more efficient organization is punished because it has a lower “cost of doing business” than a less efficient company. Let the market work. To borrow a phrase from the other side of the political spectrum: Government should not be picking winners and losers.
    Of course, that is exactly what the “conservatives” do when they allow and encourage loopholes for the wealthiest among us. Whose ox gets sacrificed?
    One of the things to keep in mind is that overall this system would lead to a reduction in everyone’s tax rates. Right now we have a phony 35% tax rate that the business community rails against. Yet, we know that no one pays that rate. In fact, the wealthiest among us, like Mr Trump, brag about paying NO TAXES because they know how to manipulate the system. As long as we allow any loopholes, every special interest will continue to demand their loophole.

    (Regarding Askimet. My own wordpress site works fine. However, when I try to post comments through wordpress I am banned. Askimet has not been able to tell me why or how this is happening. They are supposed to be the filter, which is needed, but their system seems open to abuse. I have been trying for over 6 months to resolve this with no success)
    For example,this post was not accepted by your website, so I have to leave wordpress and repost outside that system under a different address.

  9. whungerford says:

    Joseph, your missing comments are in our spam queue. Is this a problem with just this site so we might fix it? I tried selecting “not spam; which made that comment subject to approval.

  10. Joseph Urban says:

    Bill. Thanks for the info. Evidently sometime in January or February all my posts originating from my wordpress account were labeled as SPAM. I don’t know why. I appreciate your attempts to rectify that. It is not only this website, but any wordpress website. Which is why I have contacted Askimet a number of times but they seem unable to “unspam” me for some reason.

  11. whungerford says:

    Joseph, I see that your tax proposal is radically different from today’s income tax. I am suspicious of laws that purport to limit what congress can do–the debt ceiling law is an example. Even if congress would pass a tax law allowing no deductions, it is unlikely that they would stick with that. Still, I see that your idea has some good points, yet I have questions:

    • Wouldn’t it be expensive and difficult to administer?
    • Some say today’s IRS is intrusive; wouldn’t taxing every financial transaction be even more intrusive?
    • Wouldn’t your proposal be even less progressive than current law with all its imperfections?
  12. Arthur Ahrens says:

    They are going to try to skin us! The Lying Liars!

    From The New York Times: The False Promises in President Trump’s Tax Plan
    Mr. Trump says that all Americans will win big from tax cuts on businesses and the wealthy. It’s a tough sell because it’s not true. It’s never worked and never will.

  13. Joseph Urban says:

    Bill. I know my idea is radical but here are my thoughts regarding your concerns.
    1. I think it would be cheap to administer. Since there would be no deductions and loopholes it would be pretty straightforward. Simply report your gross income and take the appropriate per cent as taxes. To be honest, I have no clue what the rate would be. And I would exempt a certain amount of income as a base with no taxes at all.
    2. I don’t agree that the IRS is intrusive. It just administers the law. In fact, it is the only agency in which the employees actually make money for the government well above and beyond their salaries by catching tax cheats. I wouldn’t be taxing every financial transaction, just end of the year income statements like today.
    3.An interesting point. Is our tax system “progressive”? Don’t the very wealthy and many corporations avoid all income taxes by using loopholes. I mean I paid more tax than Trump the last 10 years. I think there is a real distinction between what we see as the “tax rates” on paper and what people actually pay. Additionally, the Soc Sec and Medicare taxes are very regressive. Folks making 25,000 a year pay a much higher percentage of SS and Medicare taxes than millionaires do.
    I think a system that starts by exempting a certain income level, say $30,000 for example, from any income taxes would be a base from which to start. Then tax all gross income above that level, either equally or with a small progressive increase.
    As I see it the main weakness in our tax code are the loopholes and deductions. Let’s end them and produce a fair system that cannot be manipulated by accountants and tax lawyers.

  14. whungerford says:

    Thanks for the explanation which I found very interesting.

    1.” It would be cheap to administer.” I see little difference for individuals, am unsure for corporations, but suspicious in case of non-profits. If I contribute to a non-profit, my contribution will be carefully recorded as I will likely claim a deduction. Without that incentive, I might better contribute anonymously.

    2. “I don’t agree that the IRS is intrusive.” Neither do I, but wouldn’t the IRS have to look much more carefully into business activity to catch cheaters? I imagine today, in the absence of an audit, the IRS need only check that the reported profit is reasonable. One problem with taxes today is that wages are surely subject to tax, while a great deal of blackmarket activity isn’t.

    3.”An interesting point. Is our tax system ‘progressive’?” I don’t believe a uniform rate is fair anymore than a flat dollar amount would be; I would prefer to equalize hardship. The principle of progressive taxation is worth defending even though current taxes aren’t as progressive as one might like. Also, as you noted, progressive income tax offsets the regressive nature of some other taxes. Perhaps your system would work better if sales and property taxes were replaced with the proposed tax.

    I’m not convinced that the main weakness in our tax code is the loopholes, nor that ending them would produce a fair system that cannot be manipulated by accountants and tax lawyers. I’m sure accountants and tax lawyers are much more resourceful than that. As long as an irresponsible Congress makes the laws, any system, however perfect, would surely go downhill from the start.

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