Which of Your Tax Loopholes Are Targeted?

Corporations are not the only beneficiaries of tax loopholes, a pejorative term for disapproval of someone else’s tax deductions and income exclusions.  Many consumers enjoy favorable treatments in income tax; state & local taxes, mortgage interest, donations, gain on primary residence sale, and non-taxable social security income.  Income such as capital gains is taxed at lower rates than wages and salaries.  Loophole beneficiaries usually feel the special treatments help achieve shared goals such as; elimination of double taxation, encouraging capital formation that enables job growth, and promoting family vitality through home ownership.

In the past, special tax treatments have been shaved to prop up government spending.  Two decades ago interest on consumer loans (e.g. autos) was deductible and the permissible total of 1040 Schedule A deductions was less limited than today.  Today’s federal outlays grossly exceed tax intake.  The right won’t budge on increasing tax rates and the left won’t budge on curbing spending – that leaves a choice between more borrowing and/or adjusting tax loopholes.  Washington will probably do both.

So which loopholes are the low hanging targets?  The national composite of the IRS 1040 and its Schedule A are stored online. They show grand total income and deduction levels and the corresponding headcounts of tax filers.  From that, the following juicy tax revenue sources will likely be in the politicians’ crosshairs for loophole harvesting.  An average tax rate of 15% is used, but it is very likely an underestimate, because the tax code is progressive and we are positing increases in taxable income.  On the other hand, payroll tax rates (for Social Security and Medicare) have already been restored to higher levels and both dividend and capital gains rates have been increased.  There are interactions between deductions we have not probed.

On Schedule A, $434 billion in State, Local and Real Estate taxes, $394 billion in Mortgage Interest, and $170 billion in Donations are claimed.  That $998 billion of deductions at an average tax rate of 15% could generate $150 billion in extra tax.  On the IRS 1040, non-taxable social security is $287 billion.  Using the same average tax rate, additional revenues due to full taxation of social security benefits would produce $43 billion more a year.  This is likely an overestimate since seniors have lower incomes than average and are lower on the progressive tax scale.  Capital gains recently has been assigned a higher tax rate, so the higher taxes are already flowing in 2013 and no additional revenue is likely to be targeted from that source.  A total of $156 billion is available from plugging big, obvious loopholes – or in politician lingo, “$1.56 trillion over 10 years.”

There are infinite ways to partially plug these holes and harvest some of the potential revenues.  Some politicians will grab for loopholes worth little in cash but which would burnish their street cred for “sticking it to the man.”  One such attempt is converting “carried interest” into income – moot if capital gains are taxed as income.  Another is fully taxing the value of employer-paid health plans, which under Obamacare are probably doomed anyway.  By now, consumers are alert for the next chapter in budgetary theatrics.

Alan Daley is a retired businessman who lives in Florida and who follows public policy from the consumer’s perspective.