How to Cap Deductions Correctly
Matthew Martin
1/15/2013 04:00:00 PM
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Here is the wrong way to limit deductions: Pass a law declaring that people who make over, say, \$500,000 per year cannot claim any deductions. This is wrong because it violates the most fundamental rule for any tax code: increasing your pre-tax income should always, always increase your after-tax income. But this reform proposal violates this rule. To see how, just suppose that you are making \$499,999 per year and claiming \$10,000 in deductions. Your boss offers you a \$1 raise. Now you make \$500,000 per year and can claim \$0 in deductions. With a top marginal tax rate of 39.6%, that means that a \$1 raise actually made you \$9,999.60 poorer.
I have a somewhat similar idea to yours here:
Replace all existing deductions with one high standard deduction -- higher than the poverty level. Replace the existing tax code with a single rate. Such a tax would be progressive (as yours is).
I would also put a 100% tax on income above some very high level, because if there is no limit to income, there is no limit to inflation. This is exactly opposite to your approach. But what's the sense of making more money if it's just inflating away?
Mine creates a window in which the distribution of income can freely move, and protects the dollar.
Art
Also, many papers in the Mirrlees literature suggest, similar to what you say, that the marginal tax rate should converge to 100% as income approaches infinity--I think this asymptotic limit would be better than jumping to 100% at a specific high income level.
Far more important than "how much" is "how" to tax. Very nice. I shall have to do some reading.
But let me point out that "as income approaches infinity" the dollar's value approaches zero... In practice, "ceteris paribus" doesn't hold.