Thu, Oct 11, 2012 - Page 9 News List

How to soften the US’ drop off the fiscal cliff

By Martin Feldstein

However, even if the intellectual objection to extra revenue can be overcome in this way, the practical political problem is that every large tax expenditure — the home mortgage interest deduction, the exclusion of employer payments for health insurance, etc — has its fervent defenders.

So here is an idea that might work: Let taxpayers keep all of the current tax expenditures, but limit the total amount by which each taxpayer can reduce his or her tax liability in this way.

I have explored the idea of “capping” the benefit that individuals can get as a percentage of their total income (“adjusted gross income,” or AGI in US tax parlance). Applying a 2 percent of AGI cap to the total benefit that an individual can receive from tax expenditures would have a very powerful effect. It would not limit the amount of deductions and exclusions to 2 percent of AGI, but rather would limit the resulting tax reduction — that is, the tax benefit — that the individual gets by using all these special features. For someone with a 15 percent marginal tax rate, a 2 percent of AGI cap would limit total deductions and exclusions to about 13 percent of AGI.

Such a cap would have a significant impact. Even if the cap were applied only to “itemized deductions” and the health insurance exclusion, it would raise about US$250 billion in the first year and about US$3 trillion over the first decade.

There are many options in designing such a policy. The cap rate could be higher, or it could start higher and be gradually tightened, or it could vary with an individual’s income level. Either way, the economic and political attractiveness of a cap consists in its ability to raise substantial revenue without eliminating specific tax expenditures.

Fixing the US’ fiscal problem will be as difficult as it is important. However, slowing the growth of Social Security benefits and capping total tax expenditures would be a good framework for the coming reform.

Martin Feldstein, professor of Economics at Harvard, was chairman of former US president Ronald Reagan’s Council of Economic Advisers and is a former president of the US National Bureau for Economic Research.

Copyright: Project Syndicate

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