The tax plan released by the House last week limits deductions for a variety of expenses, including tuition debt, mortgage interest, alimony, medical expenses, state and local taxes, gambling losses, tax-preparation expenses, and moving expenses.
The details are likely to change in the Senate, but the important point for long run is that the deductions are being challenged. Many of the changes — in particular, mortgage interest, medical expenses, and state and local taxes — are taking on powerful lobbies and constituencies. Several months ago I would not have thought the Republicans would be so bold.
If the bill succeeds in limiting these deductions, a logic is set in motion for future tax reforms. Let’s say the Republicans eliminate tax deductions for new mortgages above $500,000. That would become a sign that the homeowner and real-estate lobbies are not as strong as we might have thought. The next time tax reform comes around, legislators will consider lowering the value of the deduction further yet. After all, the anti-deduction forces won before and, in the new battle, those who expect to have future mortgages above $500,000 don’t have a stake anymore.
In other words, any squeezed deduction will remain a vulnerable target for more squeezing, or even elimination, over successive reforms.
Virtually all public finance economists, on a bipartisan basis, have opposed the mortgage interest deduction. It encourages overinvestment in housing, and most of the benefits go to relatively well-off families rather than the needy. It serves neither efficiency nor equity, and so one of the best features of the Republican plan is that it paves the way for a successive diminution of this deduction.
The state and local tax deduction has been considered hard to touch, but according to one estimate 90% of the benefits accrue to individuals earning more than $100,000 a year. If that provision can be touched in the current bill, it too might continue to be hit in future tax reforms.