Tax reforms are defined as the modifying the way that tax are managed or collected. There have been debates that individuals should have a tax choice such that they have controls to tax that they have been allocated; this is significant because it will portray the areas that the population truly value thus enabling the government to offer their services efficiently. American taxpayers are allowed a tax choice between the standard deductions and the itemized deductions. Under the United States law (Burman & Slemrod, 2013), Standard deductions is a dollar amount that reduces ones taxable income that is based on filing status and eliminates the need to itemize actual deductions. Itemized deductions refer to a reduced tax on the taxable income that is reported by an individual on their federal income tax returns. Examples of allowable itemized deductions are; medical expenses, local and state taxes paid investment interest and charitable contributions. This paper will focus on proposed reforms on itemized deductions in terms of costs and benefits and how they compare to the current laws.
Over the years the Pease limitations on itemized deduction has been subject of country-wide debate. Many individuals think that it does not make any sense. The Pease limitation is meant to reduce the estimation of taxpayer’s itemized deductions by 3% for every dollar of taxable income above a certain limit. The phase-out of the estimated value of itemized deductions is topped at 80 percent of the total value of the itemized deductions (Taxpolicycenter.org, 2015). Many of American taxpayers, this does not make sense because the 80% capping is hypothetical; in an ideal situation majority of the taxpayers will never hit the 80 percent cap. Itemized deductions are directly proportional to an individual’s income i.e. an increase individual’s income leads to an increase in the itemized deductions and vice versa. Therefore, the local and state income tax of an individual will increase with increase in his income because he has to pay more in income taxes. In this case, Pease limitations continually phases out 3% per additional dollar of a taxpayer’s itemized deductions to infinity.
Pease is less efficient in reducing the value of certain itemized deductions as it is connected to the taxpayers Adjusted Gross Income (AGI) instead of the estimated value of the itemized deductions. The cap on the Pease limitation does not change the marginal benefit of deductions. The real marginal tax rate for individuals is 40.8% but not 39.6% as perceived by many taxpayers, this has been brought about by the complexities that came with Pease limitations on itemized deductions. A simple way to increase the marginal individual tax rate for the high income earners would be just increasing the marginal tax rates (Long, 2000).
The first proposal on itemized deductions reforms would be to restrict the tax benefits on the itemized deductions to 28% of their aggregate value. The taxpayers that will be having a statutory rate of more than 28 percent will receive less benefit compared to the individual itemized deductions in the current law. The middle and low income tax payers in the statutory tax bracket equal to 28% and below would not be affected by the tax reforms. The Joint Committee on Taxation gauges that this will increase income by an average of $ 13 billion every year for the next ten years (‘Joint committee on taxation issues tax simplification study’, 2013).
The second proposal would be to limit the tax benefits of itemized deductions to 6% of the taxpayer’s Adjusted Gross Income. Individuals with savings from itemized deductions at 6% and below will be unaffected by the changes while those with savings from itemized deductions that are more than 6% of their Adjusted Gross Income will receive less benefits from itemized deductions under the current law. The Joint Committee on Taxation estimates that this approach will increase the revenues by an average of $7 billion every year for the next ten years (‘Joint committee on taxation issues tax simplification study’, 2013).
The third proposal would be to alter the current filing status i.e. the restriction of the itemized deductions for married taxpayers who file joint returns to $500,000 and that of other tax payers to half of that for married taxpayers’ i.e. $250,000. These limits should be adjusted for inflation. The married taxpayers who file joint returns with itemized deductions that exceed $500,000 and for other individuals, who exceed $250,000, would receive less benefit from the itemized deductions than under the current law. Married couples that file taxes jointly with itemized deductions equal to or less than $500,000, and other individual taxpayers with itemized deductions equal to or less than $250,000 will not be affected by the changes. The Joint Committee on taxation estimates that this approach will increase t he revenues by an average of $14 billion every year for the next ten years (‘Joint committee on taxation issues tax simplification study’, 2013).
In conclusion, the essence of the aforementioned options is to increase the efficiency of the tax code. Increasing the benefits on certain itemized deductions will lead to more of the taxpayers spending more on the favored itemized deductions (Feldstein, Feenberg & MacGuineas, 2011). For example, if the mortgage expenses have more benefits on deductions, then more taxpayers will take more mortgages and this could lead to an economic bubble similar to the 2008 credit crunch. The three alternatives mentioned above are meant to limit the benefits on itemized deductions to an optimal level to improve the tax code equilibrium and efficiency.