Tax Reform II: Lower Rates; Eliminate Deductions

As Congress considers tax reform, the focus on the personal income tax should be to lower rates and eliminate all deductions except for a standard deduction that applies to everyone.  Lower rates enough to offset the increased revenue from eliminating deductions, and set the standard deduction at a level that raises the same amount of revenue as the pre-reform tax system.  Personal income tax reform should be revenue-neutral.  That avoids debates on whether taxes should be raised or lowered and focuses on making the tax system fairer and more efficient.

I propose a flat rate of 22% on all income beyond the standard deduction.  Set the standard deduction at a level that satisfies the revenue-neutrality criterion.

Most deductions have some sort of reasonable justification behind them, but there are often arguments against them, and in all cases one of the arguments against them is that if the deductions didn’t exist, the same amount of revenue could be raised with lower rates.  Consider a few.

The home mortgage interest deduction benefits high-income earners more than low-income earners, partly because high-income earners are more likely to be homeowners and partly because they are in higher tax brackets so lower their taxes more.  That would be less of a factor with a flat rate, but still, why design elements into the tax structure that disproportionately benefit high-income people, at the expense of having higher tax rates for everyone?

The deduction for charitable contributions seems, well, charitable, until you look at what constitutes charity.  Symphonies and operas, public policy organizations, and educational institutions are often causes that may be worthwhile, but disproportionately benefit the rich.  Not all charitable organizations are that way, of course, but how do we draw the line?  Rather than trying, why not eliminate the deduction, which then would allow lower tax rates for everyone?

The deduction of state and local taxes is especially unfair.  It provides a federal subsidy for state and local government spending, encouraging state and local governments to spend more because some of the cost of their spending is shifted to residents of other states.  Why should the taxpayers in the state of Mississippi be required to subsidize state and local government spending for Californians?  Doing away with the deduction would allow lower tax rates for everyone.

We could make a similar argument for all deductions.  Just eliminate them all.  One that I might consider a special case under certain circumstances is health insurance, which I will discuss in a later blog post.

Randall G. Holcombe is Research Fellow at the Independent Institute and DeVoe Moore Professor of Economics at Florida State University. His Independent books include Housing America: Building Out of a Crisis (edited with Benjamin Powell); and Writing Off Ideas: Taxation, Foundations, and Philanthropy in America .
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