Congress can’t seem to end its love affair with tax deductions.
For a brief period starting with then-House Ways & Means Committee Chair Dave Camp’s (R-MI) 2014 tax reform plan until 2017, it looked like Congress might make a sea change in tax policy. There was surprising interest in ditching many individual income tax deductions—most with little or no economic benefit—to help pay for reductions in income tax rates.
That never quite happened, though the 2017 Tax Cuts and Jobs Act scrapped a few deductions and limited the attractiveness of others by significantly increasing the standard deduction and capping the state and local tax (SALT) deduction. By 2018, only about 10 percent of households were claiming itemized deductions.
Congress’s response to the COVID-19 pandemic may be reversing that trend. Economic relief legislation has become a traditional opportunity for lawmakers to revert to bad habits. Though the large standard deduction requires them to be a bit more creative, they once again are using the tax code to reward what they see as good economic or social behavior.
Here are just a few examples:
The Coronavirus Aid, Relief, and Economic Security Act (CARES) Act created a new $300 deduction for charitable giving by non-itemizers. This “above-the-line” deduction applies only to donations made in 2020, though few would be surprised if it becomes permanent.
The House-passed HEROES Act also includes several new or expanded deductions for taxpayers who do not itemize. They include raising from $250 to a maximum of $500 the deduction school teachers can claim for buying school supplies, a new deduction of up to $500 for unreimbursed training and other expenses of first responders, and a new temporary deduction of up to $500 to subsidize first responders and health care workers for their cost of uniforms and supplies.
The cost of these provisions is relatively modest. The congressional Joint Committee on Taxation estimates that the three HEROES Act provisions combined would cut taxes by about $5 billion over 10 years. And one could argue that government should help health care workers who have had to buy their own surgical masks and gloves during the pandemic.
The big one
Finally, there is the big one that will add $136 billion to the deficit: The HEROES Act would reverse the TCJA’s $10,000 cap on the SALT deduction for two years—temporarily undoing the biggest assault in decades on itemized deductions. Combined with the law’s doubling of the standard deduction, capping the SALT deduction made itemizing the province of mostly high-income taxpayers. And, over the long run, it may have jeopardized political support for itemized deductions as a tool for social and economic policy.
Here’s why growing interest in above-the-line deductions is a problem:
In a progressive income tax system, deductions are inherently regressive. Reducing taxable income is three times more valuable to someone in the 37 percent tax bracket than to someone in the 12 percent bracket.
A bottomless rabbit hole
In addition, deductions take policymakers down a bottomless rabbit hole as they attempt to decide what activity qualifies for a tax subsidy and who gets it. Often, the benefits go to those with the best-connected lobbyists and the biggest campaign donations, not those with the strongest economic and social policy argument. A classic example: The home mortgage interest deduction.
The HEROES proposal to use a tax deduction to subsidize health care workers for their costs of gloves and masks is a case study. Why shouldn’t it also be available to family caregivers who may be assisting a frail parent? And who qualifies as an eligible “front-line” worker? Is it just EMTs and nurses? What about home health aides? Or grocery clerks or restaurant workers?
A standard deduction helps avoid all those traps. It acknowledges that all of us have certain expenses that reduce our incomes and our ability to pay taxes. But rather than having government pick and choose which of those costs—and which of us–are worthy of a tax subsidy, the standard deduction covers a portion of these expenses for nearly all filers.
It never is easy for Congress to get rid of these deductions. A decade ago, Sen. Ron Wyden (D-OR) and then-senator Judd Gregg (R-NH) proposed scrapping some deductions and significantly increasing the standard deduction. It went nowhere. In 2014, Camp’s heroic attempt to eliminate most special interest tax breaks was sunk by his own House GOP leadership.
Former House Speaker Paul Ryan (R-WI) also tried to limit deductions to pay for lower tax rates in his early versions of what eventually became the TCJA. But that didn’t last long either. Once Republicans chose to pass the tax cut without Democratic support or much concern for increasing budget deficits, they abandoned the idea of eliminating most politically popular deductions. They recognized that absent bipartisan agreement, they’d take a terrible beating from Democrats for scrapping popular tax breaks.
In the end, the TCJA scaled back the SALT deduction (which has the largest effects on Democratic states) and modestly trimmed a few other tax breaks. It wasn’t much, but it was something. Now, it seems, Congress may be backsliding from even that modest progress.