Alternative Revenue Raisers from High Earners

As was the case two years ago, the 2001/2003 tax cuts will be a hot topic in the lame duck session. Democrats would like to extend the full tax cuts only for people making less than $250,000, while Republicans would prefer to extend them fully for most everyone (leaving out refundable tax credit expansions from 2009).

Given that there is only a month and a half until the end of the year, it is unlikely that a full re-write of the tax code will be accomplished, but a down-payment containing some revenue raisers may be necessary to make a tax reform process next year more credible. If the two parties find the upper-income tax cut fight too difficult to resolve, CRFB's newest paper presents alternate ideas for how to raise a similar amount of income exclusively from high-earners.

For background, the 2001/2003 upper-income tax cuts include cuts in income tax rates, capital gains and dividends rates, estate tax rates, and the repeal of phase-outs of personal exemptions and itemized deductions. In total, these provisions would cost $70 billion to extend for one year and $950 billion to extend over ten years (or alternatively, would save $70 billion and $950 billion compared to extending all the tax cuts).

Our paper discusses the main rationale often used for allowing the upper-income tax cuts beyond raising revenue: making the tax code more progressive. However, we point out that what matters for progressivity is effective tax rates, not marginal rates. Thus, CRFB presents alternative mechanisms for raising revenue exclusively from high-earners--roughly similar to the amount of the upper-income tax cuts--without raising marginal tax rates. Those three models are:

  • A $25,000 cap on itemized deductions, which would be phased in on income between $250,000 and $500,000. This option would raise about $60 billion in 2013.
  • A Feldstein-Feenberg-MacGuineas cap, which would limit the value of certain tax preferences to the lesser of two percent of income or $10,000 for people making over $250,000. Assuming that the cap is applied to itemized deductions, the employer health insurance exclusion, and the child tax credit, it would raise about $85 billion in 2013.
  • A limitation on itemized deductions, which limits the benefit of deductions to 28 percent. We also apply a phase-out above $300,000 so that percent limit declines to zero for people making more than $1 million. This approach is somewhat similar to one that President Obama has used in his budgets, incorporating the 28 percent limitation but not the phase-out. We estimate that this policy would raise $55 billion in 2013.
Proposal To Raise Revenue Among High Income Earners
  Revenue by Cash Income Level (2013)*
Options $0 - $200K $200K - $500K


Total Revenues
Limit Itemized Deductions to $25,000, Phasing-in Limit Between $250K to $500K $0 $7 billion  $50 billion  $57 billion
Institute a FFM Cap Applied Above $200K/$250K* $0  $20 billion  $66 billion  $86 billion
     Including Additional Tax Expenditures* $0  $30 billion  $80 billion  $110 billion
Capping and Phasing-Out Deduction To 0% Above $1 million $0  $8 billion  $46 billion  $54 billion
     Including Additional Tax Expenditures $0  $13 billion  $70 billion  $83 billion

*Revenue estimates based on AGI thresholds, which are not directly comparable to cash income.

The paper notes that any of these options are dialable, so they can be easily altered to meet a certain revenue target. In addition, it notes that there are many individual tax expenditure options that could be added that would affect primarily, if not exclusively, high earners, including taxing carried interest as ordinary income or eliminating the mortgage interest deduction for second homes.

These options for limiting tax expenditures could serve as a useful alternative to the debate over the upper-income tax cuts. These options could serve the same twin goals of increasing progressivity and raising revenue without staying stuck in the same gridlock that has surrounded the tax issue for the past few years.