The Effect on the Rich of a $50,000 Deduction Cap

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Greg Mankiw suggests that instead of letting the high-end Bush tax cuts expire, we keep the lower Bush rates on the wealthy but limit their deductions to $50,000:

According to the Tax Policy Center, if we cap itemized deductions at $50,000 and keep tax rates as they are today, we’d raise $749 billion in tax revenue over 10 years. And 96.2 percent of the extra revenue would come from the top fifth of taxpayers, with 79.9 percent from the top 1 percent.

It’s an interesting idea. But how would this affect the very wealthiest taxpayers compared to simply letting the Bush tax cuts expire? I was curious, so I took a look at the distributional analysis done a few months ago by the Tax Policy Center.

President Obama has actually proposed several changes aimed solely at high earners. First, he’d let top marginal rates go back up to 36 percent and 39.6 percent. Second, he’d limit deductions and reinstate the personal exemption phaseout. Third, he’d let the long-term capital gains rate go back up to 20 percent and he’d tax dividends at the same rate as ordinary income. So what effect would all this have on earners in the top 1% and top 0.1%?

The first set of numbers was done in 2010, while the deduction cap analysis was done in 2012, so the figures probably aren’t precisely comparable. But they’re pretty close. Bottom line: Thanks to Obama’s proposed changes in taxation of dividends and capital gains, the rich would do slightly worse under his plan than they would with a deduction cap, but not by much. Obama’s proposal would also raise a bit more money, but again, not by much. (The Treasury calculates that sunsetting the Bush tax cuts on the rich would raise about $848 billion over ten years.) Lower the deduction cap to $40,000 and both proposals would be very nearly identical.

So assuming I’ve done the arithmetic correctly, it looks as if both proposals would have a pretty similar effect on the very rich and a pretty similar effect on federal revenue. There might actually be the seeds of a compromise available here.

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