Income Tax: cut rates or deductions? | New NY 23rd

On 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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