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Sixteen days away from the fiscal cliff and Washington has yet to agree to a fiscal cliff deal.President Obama wants to raise taxes and believes he has the mandate to do so, while Republicans want tax reform but want it hand-in-hand with spending cuts.
In a new column in Foreign Affairs, Harvard University economics professor Martin Feldstein writes that burdening the top two per cent with more taxes is going too far. He also believes that President Obama’s plan would lower demand in 2013, hurting the American economy.
He favours broadening the tax base. From Foreign Affairs:
“A better way to raise revenue would be to broaden the tax base by capping the tax reductions that each taxpayer can claim. Each taxpayer would retain all of his or her existing deductions and exclusions, but the overall cap would limit the total amount by which the taxpayer could reduce his or her tax liability. The limit would apply not to the size of deductions and exclusions but to the resulting tax benefit to each individual. A cap of two per cent of each individual’s adjusted gross income — applied to the taxpayer benefits from all itemized deductions and excluding municipal bond interest and the value of employer payments for high-value health insurance — would raise about $150 billion at the 2013 level of income, or about one per cent of GDP.
…A limit on deductions would cause the number of taxpayers who itemize their deductions to fall sharply, from 47 million under current tax rules to only 18 million — a major simplification for 29 million taxpayers. The cap would also make the tax system more progressive, reducing after-tax income more for higher-income taxpayers than for lower-income taxpayers. Nearly two-thirds of the $130 billion in extra revenue would be collected from the 20 per cent of taxpayers with incomes above $100,000.
There is a danger that the resulting $130 billion of extra revenue would be too much for the economy to swallow in 2013, particularly when combined with reductions in government spending. The United States could avoid that risk by starting with a higher cap and gradually reducing it over several years. For example, a four per cent cap on the tax expenditure benefits would raise only about $65 billion in 2013.”
Feldstein of course doesn’t expect this to pass. He suggests a more reasonable alternative could involve a “fallback plan” with a cap on tax expenditures that would kick in six months down the line.