The tax compromise has passed, so at least we know what our taxes look like for the next two years. But what happens after that? What will Congress do when our economy recovers? We know we’ll need to raise more tax revenue to make up for all this federal debt, but how? The author of the NYTimes article below believes we need to rethink the charitable contributions deduction. But, will people give so generously without the tax incentive?
First, some basics. If there is one thing that most economists agree about in the realm of tax policy, it is that it’s best to broaden the base of any tax, all else being equal. That means minimizing the number of deductions and exclusions from taxable income in order to lower marginal rates and reduce distortions. N. Gregory Mankiw made this case powerfully in this space recently, and President Obama and the Bowles-Simpson fiscal commission have taken up the cause as well.
In light of our prolonged economic doldrums, a decision to cut taxes for now is both popular and justifiable. But, eventually, Congress will have to face up to the fact that to deal with the long-run deficit problem we have to raise tax revenue as well as cut spending. Many Republicans know this deep in their hearts but can’t bring themselves to actually say it, for fear of excommunication.
Broadening the base can solve this quandary because, by reducing deductions, lawmakers can cut tax rates but increase revenue. This is one type of voodoo economics that actually works.
Two deductions are likely to be central in any debate on tax reform: those for mortgage interest and for donations to charity. With the housing market still suffering, it is hard to persuade anyone to consider changing the mortgage deduction right now, so I will concentrate on charitable giving.