The idea that we could raise needed revenue by capping deductions of high-income families as opposed to raising their tax rates is gaining some traction (economist Greg Mankiw supports the alternative in the NYT this AM). For example, suppose households were allowed to deduct only $50,000 from their annual tax bill. Since wealthy families usually deduct a lot more than that, this would be a progressive way of gaining new revenue (though there are arguments about how much–certainly, well under the President’s $1.6 trillion opening bid).
But if this approach were limited to households above $250,000, as would likely be the case given that both sides have vowed to protect the “middle class” from higher taxes, there’s a real problem with it: you create another–dare I say it–tax cliff.*
Under the higher rates approach, only the marginal dollar above $250,000 is taxed at the new, higher rates. So a household that earns just above the threshold won’t notice the change. But if their deductions were suddenly capped, they’d notice it big time. Imagine a household earning $249,000 and deducting $70,000 from their taxes–if their income then goes over the threshold, they’d face a $20K tax increase. The only fair way to solve this is to phase in the capped deductions, which of course leads to revenue loss.
So I’m not saying it’s a bad idea, but if we’re talking about just applying it to the wealthy, it’s more complicated a) than folks are saying, and b) relative to the expiration of the Bush cuts for the top 2%.
*Note that the TPC estimates that a $50K cap on the deductions of all families would raise about $750 billion over 10 years, so about half of the President’s revenue ask. If the cap were restricted to families above $250K, we’d raise $200 billion less, so this idea clearly does not hold the “middle-class” harmless relative to the expiration of the upper-income cuts.