Cap tax deductions, says former Reagan economic adviser

President Obama's been making the rounds on Capitol Hill, trying to woo supporters for a grand bargain, a bipartisan agreement to reduce the deficit.

The problem is that both Democrats and Republicans are still entrenched in their traditional approaches to dealing with the country's finances. The GOP wants to take an almost total spending reduction route. Dems want to add some new revenue, aka taxes, to the mix.

As part of his effort to get the loyal opposition at least talking, Obama visited Capitol Hill on Wednesday (March 13) and met with the House Republican Conference.

Seven GOP Representatives got to question the president, including Ways and Means Chair Dave Camp (R-Mich.). But instead of asking Obama anything, Camp explained why Republicans want to enact comprehensive tax reform rather than use the elimination of loopholes as bargaining chips in any fiscal discussion.

"I just said, 'We don't want a piecemeal tax reform because then you don't get the economic growth, job creation and increased wages and benefits that we want to see,'" Camp told Roll Call. He said it was "good exchange" and that Obama "certainly listened and I think the point was made."

Deduction targets: As the two sides were conducting legislative reconnaissance, another Republican was sharing his tax advice in the Washington Post opinion section.

Martin Feldstein, a professor of economics at Harvard University and former chairman of the Council of Economic Advisers under
President Ronald Reagan, says it's time to cap tax deductions.

Actually, it's a position Feldstein advocated a month earlier in the Wall Street Journal.

Uncle Sam loses billions of dollars through a variety of relatively small
tax breaks that should be totally removed from the tax code, says Feldstein.

But the big
political and fiscal challenges are large tax subsidies — deductions for home
mortgage interest, employer-provided health insurance and state and local taxes.
Any attempt to eliminate these, notes Feldstein, would almost certainly fail.

"That is why I advocate allowing taxpayers to keep all of their
current deductions and exclusions — but limiting the extent to which
they can reduce their tax liabilities in this way," writes Feldstein.

He elaborates:

"More specifically, I believe that Congress should cap the reduction
in tax liabilities that taxpayers can gain from using these special
features of the tax code. The tax benefits should be limited to a
percentage of the individual’s total income. I favor a cap of 2 percent
of adjusted gross income (AGI) on the tax benefit that an individual
receives from deductions and from the exclusion of municipal bond
interest and of the value of employer payments for health insurance."

Feldstein
says a 2 percent limit on deductions and exclusions would raise more
than $2.1 trillion. And with that much extra revenue from
tax reform, says Feldstein, some tax rates could be cut.

Existing deduction limits: The American Taxpayer Relief Act enacted in January reinstated a limit on itemized deductions, but it applies just to higher income earners.

Beginning with the 2013 tax year, single filers making more than $250,000 and jointly filing married couples making more than $300,000 would have their itemized tax expense claims reduced by 3 percent of AGI. The earnings amounts will be adjusted annually for inflation.

But the overall deduction reduction, called the Pease rule after the congressman who originally championed it, can't
exceed 80 percent. And the limitation doesn't apply to deductions for
medical payments, investment interest expenses, wagering losses and casualty
and theft losses.

Feldstein's 2 percent reduction would apply to all taxpayers. Using just itemized deductions, a single filer making $75,000 could claim only $1,500 in deductions. One making $250,000 (the current deduction reduction threshold) would be restricted to $5,000 in deductions on Schedule A.

Charity exempted: And Feldstein also fell prey to the same trap that both tax writers and taxpayers routinely fall into. He carved out a exclusion for a tax break he favors.

Feldstein would spare charitable contributions from the deductions limit.

"The full deduction for charitable contributions should be retained," says Feldstein, "because the money that taxpayers give to charity benefits those
organizations rather than the individual taxpayer."

Feldstein says a 2 percent limit on deductions and exclusions would raise more than $2.1 trillion. And with that much extra revenue from
tax reform, says Feldstein, some tax rates could be cut.

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