For years Republican House Speaker Paul Ryan wowed the Washington pundit class by pushing his balanced budget proposals. Not only did he outline a plan for taxes and spending that balanced the budget and paid down the debt, he actually got the Congressional Budget Office (CBO) to score the proposal, verifying his claims.
As a practical matter, there was considerably less in these proposals than claimed. On the spending side, Speaker Ryan told CBO to assume a spending path for the domestically discretionary side of the budget that essentially eliminated the federal government by 2050.
While his plans still would have enough money for the Defense Department, Social Security, Medicare and Medicaid, in the Ryan budget everything else was effectively zeroed out. He puts the Justice Department, State Department, Education Department and all other departments and agencies of the federal government out of business. That is one way to balance the budget.
If Ryan had a specific, albeit extreme, plan on the spending side of the budget, he was much less specific on the tax side. He told CBO that there would be large cuts in income tax rates. These reductions in tax rates primarily benefit the wealthy, since they would get the vast majority of savings.
To keep the plan revenue neutral, Ryan told CBO to assume that he would eliminate enough tax deductions to offset the reduction in interest rates. But Ryan never indicated which tax deductions he wanted to eliminate.
This is where the magic asterisk comes in. Ryan told CBO to just assume that enough deductions would be eliminated so that total revenue would not be affected. This was not a CBO score of an actual tax proposal, it was a Paul Ryan assertion. Now that he is actually in a position to get a tax plan signed into law, we will finally get to see which deductions he would actually eliminate.
The basic problem is a simple one: The deductions that involve the sort of money needed to offset a big tax are hugely popular. The list includes the deduction for employer-provided health care insurance, the deduction for mortgage interest, the deduction for state and local income taxes, the deduction for charitable contributions and deductions for retirement savings. These are all deductions that benefit huge numbers of middle-class people who will be very upset if Ryan tries to take them away.
In looking at this list, we can probably remove the last two right off the bat. In addition to angering middle-class people, eliminating or substantially cutting back the deduction for charitable contributions will have every charity in the country up in arms. Similarly, politicians who have touted the virtues of people saving for their own retirement cannot now take away the deduction that is supposed to provide the incentive to save. It is also important to note that most of this is a tax deferral – people do pay taxes when they withdraw the money, so over the long term the amount at stake is less than it may first appear.
Turning to the remaining three items, it is unlikely that there will be huge savings on the mortgage interest deduction. Both parties endlessly tout the virtues of homeownership. The deduction can certainly be restructured to be more progressive and to provide more benefits to people who actually need it to buy a home, but this would not be a major source of savings.
The Republicans could eliminate the tax deduction for employer-provided health insurance. This will win them the votes of almost every economist in the country, while costing them the votes of almost everyone else. At most, we will see some cap on the benefits that escape taxation, sort of like the “Cadillac Tax” in the Affordable Care Act that the Republicans endlessly railed against.
This leaves the deduction for state and local taxes. The Republicans may actually be willing to attack this one for the simple reason that it will make it more difficult for more liberal states like New York and California to raise money through a progressive income tax.
As it stands, the deduction effectively means that the federal government is picking up a substantial portion of the state and local income tax paid by upper-middle-income people. If they are in the 40 percent tax bracket and they pay $10,000 in state income taxes, the federal government gives them back $4,000 of this money. It might be much harder to raise $10,000 in state taxes from these people if they had no offset from the federal government.
It is also important to note that people with the highest incomes don’t have much at stake in this one, since their deductions are already limited. So eliminating this tax deduction is primarily about getting more money for the federal government from middle-income people with the likelihood that this means less money for the more progressive state and local governments. That probably won’t sound very good to most people.
In short, we might want to tell Speaker Ryan to keep his magic asterisks and leave the tax rates for the rich alone. They have enough money already.