Republicans' Bold Tax Moves May Pay Off Later

The tax plan released by the House last week limits deductions for a variety of expenses, including tuition debt, mortgage interest, alimony, medical expenses, state and local taxes, gambling losses, tax-preparation expenses, and moving expenses. The details are likely to change in the Senate, but the important point for long run is that the deductions are being challenged. Many of the changes -- in particular, mortgage interest, medical expenses, and state and local taxes -- are taking on powerful lobbies and constituencies. Several months ago I would not have thought the Republicans would be so bold.

If the bill succeeds in limiting these deductions, a logic is set in motion for future tax reforms. Let’s say the Republicans eliminate tax deductions for new mortgages above $500,000. That would become a sign that the homeowner and real-estate lobbies are not as strong as we might have thought. The next time tax reform comes around, legislators will consider lowering the value of the deduction further yet. After all, the anti-deduction forces won before and, in the new battle, those who expect to have future mortgages above $500,000 don’t have a stake anymore.

In other words, any squeezed deduction will remain a vulnerable target for more squeezing, or even elimination, over successive reforms.

Virtually all public finance economists, on a bipartisan basis, have opposed the mortgage interest deduction. It encourages over-investment in housing, and most of the benefits go to relatively well-off families rather than the needy. It serves neither efficiency nor equity, and so one of the best features of the Republican plan is that it paves the way for a successive diminution of this deduction.

The state and local tax deduction has been considered hard to touch, but according to one estimate 90 percent of the benefits accrue to individuals earning more than $100,000 a year. If that provision can be touched in the current bill, it too might continue to be hit in future tax reforms.

How else will the Republican tax bill evolve over time? Well, just as the deductions could become politically weaker, the top marginal income tax rates could become politically stronger. The exact treatment in the House plan seems to be in flux, but the top rates from President Barack Obama’s tax reform are likely to stick in some manner. There even seems to be a rate of 45.6 percent on some earners, in the range of $1.2 million to $1.6 million a year. That is a far cry from Jeb Bush’s call in the Republican presidential primaries for a 28 percent top marginal rate, in the tradition of President Ronald Reagan. Some well-off Californians could possibly face a total marginal rate, all taxes considered, of over 62 percent.

You will recall that the Republican Party had in the past pressed strongly for reductions in the capital-gains rates, but that isn’t on the agenda now. Take that as a sign that Obama’s boost to those rates will stick.

The elimination of the inheritance tax has occasioned strong criticism, but note that the repeal doesn’t come until 2024. That means it could easily be reversed; tax planners are already advising clients with a future inheritance tax in mind. In the meantime, the supposed but non-credible cut in the tax won’t boost positive incentives in the way that a truly permanent removal might do, so there won’t be much in the way of locked-in benefits. In sum, the estate tax is likely to return, keeping in mind that the country will need lots of additional revenue at some point.

If we look at the Republican plan as a whole, it appears to be a recipe for a future tax code with many fewer deductions, lower corporate rates, higher income tax rates for the wealthy and a continuing inheritance tax. I’m not saying that the exact mix will or should make everyone perfectly happy, but is this not what a bipartisan tax reform compromise might look like?

In turning all branches of the federal government over to Republicans, in a relatively ideological and polarized time, would it not be strange if that proved to be a path to a bipartisan-like solution?