Analysis of Romney's Tax Plan With and Without a $25,000 Cap on Itemized Deductions

October 19, 2012

Note: Earlier we published an a paper on the economic and budget effects of Romney's tax plan, with and without his proposed $17,000 cap on itemized deductions. In the second debate between the presidential candidates, Governor Romney floated a proposal to limit itemized deductions to $25,000. We modeled this new deduction cap and here are the results.

Either cap on itemized deductions would offset a portion of the Romney tax rate cuts, mainly for upper income taxpayers. In the aggregate, we estimate that the $25,000 cap would raise roughly $1.3 trillion in revenue over ten years, on a static basis (versus about $1.75 trillion for the $17,000 cap).
 
The Romney tax plan, before considering the deduction caps, would add close to 7.5 percent to the GDP over time, resulting in additional tax revenue sufficient on a “dynamic” basis to offset about 60 percent of the initial “static” cost of the tax plan. The deduction caps would cover a large portion of the remaining net revenue cost, although they would reduce the gains in economic growth slightly. 
 
We estimate that, in dynamic terms, the combination of higher economic output and the $25,000 itemized deduction cap would offset about 83 percent of the static revenue loss of the Romney tax cuts, as opposed to 93 percent under the $17,000 cap. This leaves relatively little to be recovered through spending restraint or other tax offsets.
 
The $25,000 cap would trim about 0.3 percent off the 7.4 percent growth in the economy that the Romney plan would produce without a cap. The $17,000 cap would trim more growth, about 0.4 percent. 
 
There is a bit more GDP and income growth, about 0.1 percent of GDP, with the higher cap, because taxpayers experience less of an increase in the effective state income tax rate on labor and capital income. Wages, in all income classes across the board, would be about 0.1 percent higher under the higher cap because of a bit more additional capital formation and productivity affecting all earners.
 
On a per taxpayer basis, the $25,000 proposal reduces the Romney tax cut by less than the $17,000 cap. Averaged over all taxpayers, the difference is about $10 to $110 for taxpayers in the $2,000 to $75,000 income ranges (leaving them that much more of the initial tax reduction), and about $250 to $2,000 in higher income ranges.
 

Difference in GDP, Incomes, and Federal Budget Totals Under Romney Tax Plan With and Without the Suggested $25,000 Cap on Itemized Deductions

(Dollar amounts in billions except as noted. Calculated at 2008 levels of income.)

Changes in: With $25,000 Cap Without Cap Difference
GDP 7.1% 7.4% -0.3%
Private business GDP 7.5% 7.8% -0.3%
Capital stock 17.8% 18.6% -0.8%
Wage rate 4.6% 4.7% -0.2%
Hours worked 2.8% 3.0% -0.2%
Federal revenue -$39 -$137 $98
Federal expenditure $33 $34 -$1
Federal deficit (- is larger def.) -$72 -$171 $99
Static revenue -$234 -$338 $104
Dynamic revenue -$39 -$137 $98
% Rev. reflow -83% 59% -143%
GDP $1,021 $1,067 -$46
$GDP/$tax rev. vs. baseline* $25.87 $7.77 -$0.47
*In dollars.  Positive numbers indicate that the government would lose revenue with these tax cuts, but that economic output (GDP) and people's pretax incomes would rise by the nearly $26 or $ 8 for each dollar of revenue lost.  The negative number in the difference column indicates the smaller tax cut would cost the public $0.47 in lost income in addition to each $1 in tax saved by the government from the smaller tax cut under the itemized deduction cap compared to no cap.

 

Comparison of Changes in After-tax Incomes Under Romney Tax Plan With and Without the Suggested $25,000 Cap on Itemized Deductions

  Average Change in Dollars per Tax Return*   Average Percentage Change per Tax Return*
  With $25,000 Limit   Without $25,000 Limit   With $25,000 Limit   Without $25,000 Limit
  After-Tax AGI   After-Tax AGI   After-Tax AGI   After-Tax AGI
AGI Class Static Dynamic   Static Dynamic   Static Dynamic   Static Dynamic
< 0 131 -6,541   131 -6,845   -0.15% 7.40%   -0.15% 7.74%
0 - 5,000 0 182   0 190   0.02% 6.64%   0.02% 6.94%
5,000 - 10,000 7 527   7 551   0.09% 6.56%   0.09% 6.84%
10,000 - 20,000 54 1,064   54 1,110   0.35% 6.82%   0.35% 7.11%
20,000 - 30,000 174 1,822   174 1,897   0.71% 7.40%   0.71% 7.70%
30,000 - 40,000 339 2,615   349 2,730   1.02% 7.86%   1.05% 8.20%
40,000 - 50,000 508 3,371   531 3,526   1.20% 7.97%   1.26% 8.34%
50,000 - 75,000 786 4,717   855 4,969   1.37% 8.20%   1.49% 8.64%
75,000 - 100,000 1,114 6,624   1,277 7,045   1.38% 8.21%   1.58% 8.73%
100,000 - 150,000 1,889 9,366   2,471 10,310   1.72% 8.51%   2.25% 9.37%
150,000 - 200,000 4,216 14,071   6,267 16,644   2.86% 9.55%   4.25% 11.30%
200,000 - 250,000 6,913 19,108   10,583 23,586   3.72% 10.29%   5.70% 12.70%
250,000 - 500,000 10,635 28,751   18,734 37,784   3.94% 10.66%   6.94% 14.00%
500,000 - 1,000,000 14,201 51,090   33,119 71,765   2.70% 9.71%   6.29% 13.64%
> 1,000,000 26,456 213,876   121,859 318,331   1.03% 8.35%   4.76% 12.42%
 TOTAL FOR ALL 826 4,211   1,375 4,923   1.66% 8.48%   2.77% 9.91%
*Change in after-tax income: Static column is initial change in tax.  
Dynamic column adds change in income and income tax due to economic expansion.  
All dollars figures are in 2008 dollars, all changes are calculated relative to a 2008 GDP baseline.

 

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