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Two new reports examine how tax expenditures are distributed among income groups and identify proposals to limit itemized deductions.

Two Reports Examine the Distribution of Tax Expenditures and Reform of Itemized Deductions

  • 6/12/2013

Two Reports Examine the Distribution of Tax Expenditures and Reform of Itemized Deductions

Certain to influence the current tax reform debate taking place in Congress, two new reports by government researchers examine how tax expenditures are distributed among income groups and identify proposals to limit itemized deductions.

The most common tax expenditures are distributed unevenly across income groups, the Congressional Budget Office (CBO) told Congress in their report, The Distribution of Major Tax Expenditures in the Individual Income Tax System. In a separate report, the Congressional Research Service (CRS) reminded lawmakers that itemized deductions have broad support and eliminating any of them is likely to encounter resistance.

CBO noted that the disparity in benefits among income groups may be affected by implementation of various provisions in the Patient Protection and Affordable Care Act (PPACA), particularly the Code Sec. 36B health insurance premium assistance tax credit, after 2013. Higher income individuals will not benefit from the Code Sec. 36B credit to the extent that lower and middle income taxpayers will benefit, CBO explained, because the credit is based on a taxpayer’s income relative to the federal poverty level.

Tax incentives

CBO examined some of the largest tax expenditures for individuals, including the exclusion for employer-provided health insurance, the state and local tax deduction, the mortgage interest deduction, the deduction for contributions to charitable organizations, the child tax credit, the earned income credit, special tax rules for contributions to retirement accounts, and preferential tax rates on capital gains and dividends. These tax expenditures, CBO reported, are estimated to total more than $900 billion in 2013, representing 5.7 percent of the nation’s gross domestic product.

More than 50 percent of the combined benefits of these incentives accrue to the households that make up one-fifth of taxpayers with the highest before-tax income, CBO reported. The tax benefits of itemized deductions (state and local taxes, mortgage interest, and charitable contributions) increase significantly with income, CBO reported. Overall, these three deductions are expected to reduce tax liabilities by $140 billion in 2013. Similarly, the tax benefits of preferential tax rates for qualified capital gains and dividends increase with income. Virtually all of the benefits from preferential tax rates on qualified capital gains and dividends accrue to the top one-fifth of households. Within the top one-fifth, the benefits are heavily concentrated in the top one percent of households, CBO reported.

According to CBO, the top 1 percent of households should receive more than two-thirds of the total benefit from the preferential tax rates on capital gains and dividends in 2013.

Itemized deductions

CRS reviewed proposals across-the-board and individually tailored proposals to limit itemized deductions and their potential to contribute to revenue-neutral reductions in income tax rates. CRS noted that the “Pease limitationˮ applies to taxpayers with adjusted gross income (AGI) over $250,000; $275,000 for head of household; and $300,000 for married joint filers. According to CRS, “Peaseˮ is not a true limit on deductions, but rather an increased tax rate because it is triggered by an AGI threshold and not the amount of deductions claimed by the taxpayer. For affected taxpayers, the total of certain itemized deductions is reduced by 3 percent of the amount of AGI exceeding the threshold. The total reduction, however, cannot be greater than 80 percent of the value of the deductions and the taxpayer has the option of taking the standard deduction, CRS observed.

President Obama has proposed limiting the tax rate that applies to itemized deductions, certain above-the-line deductions, and certain income exclusions to 28 percent for taxpayers in the top three rate brackets (33, 35, and 39.6 percent). One proposal to reform itemized deductions would use caps in the form of an across-the-board limit on itemized deductions based on a flat dollar-value (such as $17,000 or $50,000 per taxpayer or family). Different versions of ˮSimpson-Bowlesˮ plans have called for eliminating all itemized deductions to lower overall tax rates.

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