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Proposal To Limit US Tax Deductions Resurfaces

The resurfacing, in a recent newspaper article, of a proposal by Harvard economics professor Martin Feldstein to limit itemized deductions at 2% of an individual taxpayer's income, so as to reduce the United States fiscal deficit, would slow economic growth, according to a new analysis by the Tax Foundation (TF).

In his op-ed in the Washington Post, Feldstein wrote that, in order to break the budgetary political impasse and replace the current spending 'sequester,' he favored 'a cap of 2% of adjusted gross income (AGI) on the tax benefit that an individual receives from deductions and from the exclusion of municipal bond interest and of the value of employer payments for health insurance. For someone with a 25% marginal tax rate, that 2% limit on the reduction in taxes translates into a limit of 8% of AGI on the deductions and exclusions.'

The 2% cap would be applied to all deductions except the one for charitable contributions, and, he calculated, 'would produce about USD140bn in additional revenue if it were applied in 2013. Over the next decade, the additional deficit reduction would total more than USD2.1 trillion.'

While agreeing with Feldstein's calculations of additional revenue on a static conventional basis, the TF's dynamic simulation (where macroeconomic aggregates, such as national output, employment and investment, are affected by the increased taxes) finds that the higher marginal tax rates stemming from the cap would depress economic activity.

The TF's model estimates that once the US gross domestic product (GDP) has adjusted to the new tax rules, 'the smaller economy would have a negative feedback on tax revenues, taking away an estimated 15% of the money the Feldstein limitation would otherwise collect.

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