Even More Tax Reform…

Below, Mike O’Hare raises some issues with Mike Graetz’s proposal for tax reform, as interpreted through my abbreviated discussion of it. We agree on one issue, and disagree on on the other.

First, I agree that we ought to axe the mortgage interest deduction entirely. The Oakeshottean in me is queasy with the unpredictable effects of such a change, given that the deduction is so woven through our society in ways that are hard to specify. But the negative effects of the deduction are so large, as Mike describes, that I’d probably be willing to swallow hard and get rid of it. That said, I think Mike may miss the point of Graetz’s design. Graetz doesn’t get rid of the mortgage interest deduction because, as I recall, he doesn’t get rid of ANY deductions. He simply eliminates them entirely for families under $100,000, because the income tax doesn’t start until then. So a pure policy analyst would say, “hey, why not get rid of all those deductions for higher earners? Why say you’re doing tax reform and preserve all the deductions?” To which I (channeling Graetz) would say, we now have plenty of evidence that doing comprehensive tax reform via eliminating broad based deductions to lower rates doesn’t work. We had a laboratory experiment, and the code just went back to what it was pre-reform. Graetz’s gamble is that when you eliminate the income tax entirely for middle-earners, that the coalition for deductions starts to become very vulnerable (since you can’t say any more than they’re really there to help hard-working average Americans, who will now no longer pay income tax). It then becomes politically feasible to eliminate deductions, especially if the alternative is either raising rates on upper earners or raising VAT on everyone else. So, to Mike, I’d say that Graetz’s proposal is the most likely thing out there that I can think of that might actually get what we both want where the mortgage interest deduction is concerned, and do so durably (I would note that much of my thinking on the politics of this has been influenced by Eric Patashnik of UVA, whose upcoming book on policy durability is going to be a blockbuster).

The good policy analyst that he is, Mike has identified the most important dislocation that any broad-scale tax reform would involve, and that’s the change to our system of non-profit finance. I agree with Mike that this is a big problem, albeit one that effects any change that reduces rates (because every reduction in rates reduces the value of deductions). So, instead of telling Mike he’s all mixed up (which he’s not), I’ll reply by asking him what change in Graetz’s plan would preserve the most of the benefits of the charitable deduction without unwinding the structure of the rest of the plan? Is there a way to ensure a flow of funds both from the wealthy and the non-wealthy? My temptation is to think that the problem among the $100k+ people is not that severe–how sensitive are charitable donations to shifts in marginal rates anyways? So my instinct is that the real problem is among the under-$100k folks. Comments and suggestions from our skilled readers are especially welcome. Any non-crock proposals will be passed along to Graetz.

Author: Steven M. Teles

Steven Teles is a Visiting Fellow at the Yale Center for the Study of American Politics. He is the author of Whose Welfare? AFDC and Elite Politics (University Press of Kansas), and co-editor of Ethnicity, Social Mobility and Public Policy (Cambridge). He is currently completing a book on the evolution of the conservative legal movement, co-editing a book on conservatism and American Political Development, and beginning a project on integrating political analysis into policy analysis. He has also written journal articles and book chapters on international free market think tanks, normative issues in policy analysis, pensions and affirmative action policy in Britain, US-China policy and federalism. He has taught at Brandeis, Boston University, Holy Cross, and Hamilton colleges, and been a research fellow at Harvard, Princeton and the University of London.