The voices of Tax Policy Center's researchers and staff
Despite all their rhetoric about closing special interest loopholes, politicians love nothing more than delivering federal largesse to favored constituents. But with new spending programs in such disfavor in Washington these days, targeted tax cuts are one of the few remaining ways to deliver the pork. But Congress has a problem: The Tax Cuts and Jobs Act would make itemized individual income tax deductions irrelevant for more than 90 percent of US households. What to do?
Fear not. Congress has other ways to distribute tax benefits. As itemized deductions fade, at least for the masses, look for lawmakers to turn to tax credits and above-the-line deductions, which people can take even without itemizing.
The fate of itemized deductions
Before we look at them, a quick reminder about what the TCJA would do to itemized deductions. The House-passed bill would chip away at several, including those for state and local taxes, mortgage interest, medical expenses, casualty losses, and interest on student loans. The Senate Finance panel, by contrast, eliminates one big one—the state and local tax (SALT) deduction—and a few smaller ones. But the SALT deduction is a major reason why households itemize at all.
Both bills would make a more important change, however. They’d significantly increase the standard deduction to $12,000 for singles and roughly $24,000 for married couples. When combined with the Senate Finance Committee’s proposed full repeal of the SALT deduction and the House bill’s repeal of the deduction for state and local income and sales taxes, itemizing would make no sense for the vast majority of households. Unless a couple has more than $24,000 in itemized deductions—and few do-- they’d be better off just taking the standard deduction.
Fewer than 10 percent would itemize
Today, only about one-third of households itemize. That would fall to less than 10 percent under either bill. The Tax Policy Center estimates that under the Finance panel bill, the number of itemizers in 2019 would fall from about 49 million to just 10 million.
As a result, creating modest new itemized deductions would be much less attractive than it is today. After all, a new deduction likely would benefit only a small fraction of voters. Indeed, with itemizing left to only a relative handful of high-income households, political pressure would grow to scale back those tax breaks even more.
So what is a politician to do? One solution would be to increase the number or generosity of above-the-line deductions that would be available to those taking the standard deduction. There already are a bunch, such as deductions for retirement savings and medical costs for the self-employed, moving expenses, alimony, tuition, and the out-of-pocket cost of school supplies purchased by teachers.
The House version of the TCJA would eliminate some of these and the Senate bill would repeal the moving expense deduction. But it would also make the deduction for teacher expenses more generous.
Converting to credits
Policy experts are proposing other ways non-itemizers can benefit from deductions. For example, my Tax Policy Center colleague Gene Steuerle has proposed a new deduction for charitable gifts in excess of 1.8 percent of Adjusted Gross Income that would be allowed for non-itemizers.
The other solution would be to convert some deductions to credits, which also would be available to all taxpayers whether they itemize or not. Done properly, that shift would make a lot of sense. In contrast to deductions that benefit top-bracket households the most, credits would provide an equal amount of tax reduction to all households, thus better targeting those with low- and moderate incomes.
Here’s why: With the existing tax rates, a $1 deduction is worth 39.6 cents to someone in the top bracket but only 10 cents to a taxpayer in the lowest bracket. Bu contrast, a credit of $500 is worth the same $500 no matter what tax bracket you are in.
Congress is already moving in this direction. For example, the House and Senate Finance versions of the TCJA would both expand the child credit. The House would create a new $300 personal credit for non-child dependents.
Lawmakers could even use the shift to credits as an opportunity to improve tax subsidies. For example, Congress could replace the mortgage interest deduction with a first-time homebuyer tax credit. This would not only help those who need the assistance the most, it would subsidize homeownership rather than mortgage debt.
The TCJA may limit both the economic and political value of itemized deductions. But Congress still has plenty of other ways to parcel out targeted tax breaks.
Posts and comments are solely the opinion of the author and not that of the Tax Policy Center, Urban Institute, or Brookings Institution.