10

What would be the broader economic impact of eliminating all personal income tax deductions in the United States, across the board? Take two basic scenarios: a) eliminating all income tax deductions, and leaving tax rates the same, increasing tax revenue as well as effective marginal tax rate; or b) eliminating all income tax deductions, and lowering marginal tax rates to keep tax revenues the same.

It seems that most deductions are regressive, as the wealthy have greater opportunity to take advantage of them, both because they have more money to put into buying a home, donating to charities, saving in a 401k, and so forth; and because they can afford a tax professional to maximize their deductions and minimize their tax burden.

I can think of some obvious, direct consequences, but I don't have the economics background to guess what the broader impact would be. First to come to mind:

  • Companies like H&R Block, Intuit, and the like, would feel serious pain, as would smaller independent CPAs.
  • The middle and upper classes would save time and money due to simpler tax returns they could prepare themselves easily.
  • The IRS' costs would be reduced dramatically, as improper deductions are the primary cause for audits, and take up the most time during an audit, of a personal income tax return.
  • Some IRS employees, both auditors and those processing tax returns, would lose their jobs as less labor would be required by the IRS.
  • All those businesses that benefit from deductions would take a hit; mortgage lenders, real estate agents, nonprofits, religious institutions, automakers, energy-efficient appliance and building supplies manufacturers, and so forth.
  • Lobbyists whose tactics revolve around arranging advantageous tax deductions for a given industry would be impacted - this may be good or bad depending on your point of view.

These are the obvious things that might happen within months of such a change in tax law. My question is: what happens next? Is there some dire consequence I'm not seeing? The societal advantage of tax deductions seems next to nil to me.

  • 3
    I used to work at an accountancy. When I asked if the Flat Tax would kill us, my boss said, "Even figuring out what is income can be tricky. As such, no, eliminating all deductions wouldn't hurt us as much as you think." – Affable Geek Jun 9 '13 at 12:12
  • Amen. Ditto TurboTax. I don't want to be filling out those forms myself even if they are simplified (and if I'm ever nominated to SecTreasury post, have no patsy to blame not paying taxes on). – user4012 Jun 10 '13 at 13:46
  • The obvious that you are missing is that MOST people can barely afford the taxes they pay now. Most people couldn't afford to pay higher taxes and even if they could it would come at the expense of other spending they would normally do. Thus, the local economy in many areas that don't have influential and good pork project representatives in congress would suffer dramatically. Addtionally, you miss the fact that as usual, in the end it's always the middle class that pays the taxes. The rich will still find the loopholes or ways to pass on the taxes. So even less local spending. – Dunk Jun 12 '13 at 19:30
  • @Dunk - I agree about the impact on the poor, however, they would feel a much smaller impact as fewer deductions are available to them. A small reduction in marginal tax rates could compensate. Not sure what you mean about the rich - if there are no deductions, the only loopholes left are to start siphoning money through foreign countries with more lax tax laws, which they're already doing anyone (along with Google, GE, etc.) – Adrian Jun 12 '13 at 22:01
  • Small point of clarification, are you only interested in personal income taxes, and are you only interested in deductions (not credits)? – user1873 Jun 16 '13 at 21:05
5

The purpose of tax deductions is usually to stimulate or incentivize certain kind of behavior and punish other kinds of behavior. So, deductions on 401k makes people save for their pensions in specially selected funds, instead of spending money immediately or maybe investing them in very risky assets.

They also give competitive advantage to certain businesses against others - so, certain "green" businesses get preferential tax treatment compared to, say, traditional energy companies, thus making it more profitable to engage in, say, wind energy than in building other means of generating electricity.

Removing these would mean the government loses significant measure of control over the economy, losing the ability to incentivize certain areas over certain other areas. It will also make certain local government unable to woo certain businesses to their localities by promising them preferential tax treatment.

Is these effects "dire" or not depends on your opinion on the role of the government. If you are a minarchist who believes the government ought to limit itself to protecting the natural rights, you would say it is a great consequence. If you believe in activist government that should take prominent role in regulating the economy and shaping economic activities, you would say it is a disaster. You can judge from the current composition of US governing bodies how many of the people share each of those opinions, and consequently evaluate the chance of such reform ever be enacted. My assumption is it is a vanishingly small chance.

  • 1
    "Competitive advantage to certain businesses ..." and the rest (2/3rds) of the answer have nothing to do with personal income tax deductions. – user1873 Jun 13 '13 at 5:19
  • @user1873 For personal deductions, it is the same idea - control over the behavior and ability for social engineering. One more example, besides 401k: if Obamacare's individual mandate (which was legalized as a tax) would not be able to work, i.e. if it would not be possible to treat people that buy insurance and that do not tax-wise, there would be no way to force people who do not want to contribute into the system and the whole model would unravel and completely different one (politically much harder to pass) would have to be proposed. – StasM Jun 13 '13 at 9:18
  • 1
    I think you missed the point here again. You just showed how it is possible to tax (stick) people differently to control their behavior with Obamacare. That makes it a poor argument for why you need deductions (carrot) to control their behavior. – user1873 Jun 13 '13 at 15:18
  • So yo just asking why won't we reformulate deductions as "tax penalties for people that don't do the other thing?" How would that make any difference except further confuse the matter? – StasM Jun 13 '13 at 16:56
  • 2
    Incentivizing is pretty much the entire reason for tax deductions. This answer seems fine. – user1530 Jun 17 '13 at 16:01

You must log in to answer this question.

Not the answer you're looking for? Browse other questions tagged .