What is a legitimate tax deduction?

Uncategorized

With this week’s passing of a budget blueprint, it looks like several contentious tax deductions could be potential sticking points as things move forward. I favor a flat or fair (sales) tax at a lower rate for everyone without deductions, but there’s a rational way to assess deductions if you must have some. Most of them don’t pass muster.

The first thing to keep in mind is that every deduction must be coupled with higher tax rates to generate the same revenue. Therefore, supporting a deduction means that you are also supporting a higher rate for those who cannot claim it.

For example, the mortgage interest deduction allows taxpayers who purchase homes to pay less in taxes at the expense of their neighbors who purchase cheaper homes or rent instead. Proponents claim that it promoted home ownership, but politicians should not be crafting tax codes to reward one group at the expense of another. We’re addicted to this one, but it should be phased out.

Consider the state and local income tax deduction, which reduces taxable income by the amount paid in state and local taxes. With this deduction, a taxpayer in a 30% federal bracket reduces his or her taxes by 30% of the amount paid locally, favoring those in high-tax locations like New York, New Jersey, and California, at the expense of Americans in other states. Like the mortgage interest deduction, there’s no rational basis for this one either.

There are a few rational deductions, however. Consider charitable contributions. When you contribute a dollar to charity, you are assigning the income to that organization. You receive no direct benefit from the dollar, so it’s reasonable that are not taxed for it. Likewise, 401(k) contributions assign your income today to a future period. It’s rational that you should be able to defer the taxes you pay into the future as well.

There are exceptions, but if you apply basic logic and rationality, most deductions in the tax code fall short. Unfortunately, the current debates focus on who’s losing what instead of the legitimacy of the deduction. For example, proponents of the state and local income tax deduction argue that taxpayers in certain states won’t get much of a tax cut if this deduction is eliminated. This artificial standard assumes that tax reform would reduce everyone’s taxes proportionally, but the only way to do this is to retain all of the deductions. This is why a tax cut is likely to pass, real reform is not, and a tax cut without meaningful reform would continue the ongoing back-and-forth shift that increases the burden on the most productive and creates a growing percentage of non-payers.

2 Comments

2 Comments

  1. DarSet  •  Oct 29, 2017 @8:35 AM

    why don’t we get rid of all deductions and just have a flat tax?

  2. Ron_C  •  Oct 31, 2017 @3:17 PM

    I hear they are caving on SALT. Blog is right about this. Crony deduction!