Obama’s Proposed Limitation on Itemized Deductions Is Better than Surtax

July 8, 2009

Unfortunately in Washington and in state capitals, policymakers rarely pursue 1st best policies. In fact, it’s rare that we even get the 2nd best policy. So we end up having to make judgments about two or more policy proposals that are far from the ideal. (Almost every internal argument among Tax Foundation research staff comes from this.) Such is the case we are faced with on the issue of raising revenue to finance a greater role for government in health insurance.

Beyond the question of whether government should become more involved (assuming it will) is the question of how it should raise revenue. The best proposal on the table was to limit the exclusion for employer-provided health insurance. Unfortunately, that now appears to be dead. Another proposal we’ve seen is the one put forth by the Obama administration, which would limit the value of itemized deductions that high-income individuals are allowed to deduct from AGI. Because this proposal touches (albeit ever so slightly) the sacred cows of the mortgage interest deduction and the charitable deduction, members of Congress in both parties don’t like this either. This proposal is far better than merely raising marginal rates, which gets me to the proposal that is more likely to pass out of the House: a new surtax on high-income tax returns.

According to the Bloomberg article by Ryan Donmoyer, the surtax would be similar to the one Rangel proposed in 2007 during AMT Saga, 2007 Version. That surtax would have imposed a 4 percent surtax on all AGI above $250,000, thereby raising top statutory marginal tax rates from 35 to 39 and assuming the tax cuts expire, from 39.6 to 43.6. If you add a typical state’s top marginal rate, we would be in a range of the government taking about half of every next dollar that a high-income taxpayer made.

Somehow, according to the Democrats in Congress, I guess, raising taxes on the rich is okay only if you do it in one of the worst possible ways.

While the Republicans continue to attack the administration over Obama’s new initiatives on health care and cap-and-trade, at least the president is tackling the revenue side of these issues in a good way. On cap-and-trade, the climate revenues proposed in his budget don’t involve handouts to various industries like the Waxman-Markey bill, and his Health Care Reserve Fund doesn’t plan to significantly raise taxes in a higly distorting manner like this surtax. (The “loophole” closers on international tax are questionable.)

I’ll re-state my ideal proposal:

Instead of giving away $80 billion in [carbon] permits per year, why not use that as a significant down payment on your health care agenda? And then if you believe that these revenue levels from carbon permits will not be around forever, gradually eliminate (or limit) the exclusion of employer-provided health insurance by say not indexing a $20,000 threshold for inflation. This would reduce many of the transitional effects of imposing greater limitations on the current exclusion.

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