Reality of Tax Reform: Less Charity, Smaller Homes, Higher State Taxes

12/01/2012 12:00 AM

11/30/2012 7:23 PM

“Base-broadening, rate-lowering tax reform.” It sounds so good, right? But what if you call it what it really is? Charity-destroying, home-shrinking, state-burdening tax reform.

Doesn’t sound as good, does it?

But that’s really what we’re talking about. The term “base-broadening, rate-lowering tax reform” has the advantage of vagueness: No one knows what it means. But the practical definition, at least the one that’s emerging in the ongoing “fiscal cliff” negotiations, is tax reform that limits itemized deductions among high-income taxpayers. And as former OMB director Peter Orszag points out, 90 percent of the value of those deductions comes from just three categories: “taxes paid (mostly state and local taxes), home-mortgage interest and charitable contributions.”

So when we say “base-broading, rate-lowering tax reform,” here’s what we’re really saying: Tax reform that’s paid for by cutting tax breaks for charities, homes, and state and local taxes.

Most economists will tell you that cutting the home-mortgage interest deduction, particularly for high-income taxpayers, is a good idea. There’s no real reason the tax code should be subsidizing McMansions. But cutting the break for charities is more complicated. As Orszag writes:

“In 2009, households with incomes of more than $200,000 claimed almost $60 billion in charitable deductions — or about 20 percent of total charitable giving in the U.S. that year. Households with incomes of more than $10 million claimed an average of $1.75 million each in charitable donations in 2009, and they accounted for roughly 5 percent of all giving.

”Charitable giving reacts to tax incentives, and in response to any limits on deductions it could even fall by about the same amount as the increase in the tax bill, according to John List of the University of Chicago, who recently reviewed the literature on this subject. Other studies have suggested an effect about half as large. Even that smaller estimate, though, suggests that limiting deductions to $50,000 a year could easily reduce giving by tens of billions of dollars.“

This hasn’t been lost on the charitable sector. The Wall Street Journal reports that charities are already mounting an overwhelming lobbying effort to protect themselves, and they’re already having some success.

”I want to encourage charitable giving in this country. I think a country that doesn’t do that is a country that’s going to be in real trouble,“ Sen. Orrin Hatch, R-Utah, told the Journal. He said he is going to protect charities from being hurt in the deficit talks ‘if I can help it.’”

Hatch probably can help it: He’s the ranking Republican on the Senate Finance Committee.

Then there’s the deductibility for state and local taxes. Removing that deduction will pound taxpayers who reside in high-tax cities or states — which means it’ll hit those cities and states by making them less attractive places to live. And note the political economy: those states and cities are disproportionately blue. All 10 of the highest-tax states went for Obama in 2012, while eight of the 10 lowest-tax states went for Romney.

“Base-broadening, rate-lowering tax reform” isn’t magic. It’s more of a magic trick: It relies on obfuscation and misdirection to distract the audience from the tax increases.

But limiting itemized deductions in order to raise revenues is a tax increase, and we should be honest about where it’s coming from. The answer, overwhelmingly, is charitable deductions, the home-mortgage interest deduction, and the state and local tax deduction. Perhaps it’s better to raise taxes on those activities rather than raise marginal rates. But that’s the conversation we need to be having. Repeating the term “base-broadening, rate-lowering tax reform” over and over again isn’t getting us anywhere.

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