The Progressive Deduction Model For Millionaires

The fairness of the U.S. system of taxation has recently become a hot-button political topic. The release of Romney's 2010 tax return showing he paid less than 14% of his income to the IRS brought the issue to the forefront; and President Obama making the Buffett Rule the centerpiece of his State of the Union ensured that the debate over equitable taxation will be sticking around for a while. According to public opinion polls at least, this is a fight that the President certainly wants to have. Almost any proposal that requires millionaires to pay a higher tax rate has overwhelming support, whether through a Buffett Rule or a millionaire's surtax.  Unfortunately, despite support from their own rank and file, Republican congressional leaders have blocked any effort to make the wealthiest Americans pay their fair share.   

If Republicans in Congress refuse to raise marginal tax rates on the wealthy, then what about taking away deductions?  Unlike raising rates, this option appears to have very little public support. The resistance to this makes sense.  The primary function of tax deductions is to promote "the good" as determined by the public.  People generally believe that you should not be penalized for, nor deterred from home-ownership, charitable giving, going to college, medical expenses and saving for retirement; so we have deductions pertaining to all these things.  I tend to agree with this as well.

So if we can't raise marginal rates on millionaires or take away their deductions, what can we do?  I think I may have a solution: progressive deductions for millionaires.  The biggest problem with tax deductions is that they are regressive: the wealthy get larger tax breaks than the middle class for the exact same deductions and in the exact same amounts.  For example, a person making $80,000 that donates $5,000 to charity would save $1,250 in taxes; however a person making $1,000,000 that donates the same amount would save $1,750 in federal taxes--$500 more!  This is because deductions shave money off the top, and therefore the taxes saved are from the person's highest marginal tax rate.  This seems unfair.  Certainly you don't want to dissuade millionaire's from giving to charity, etc.  But should they get a vastly larger break than average people for doing so? 

It seems like one fix to this issue is to change the way millionaires factor in deductions; by shaving them off the bottom of their income instead of the top.  Then have them start calculating their tax in the bracket of whatever bracket their deduction falls in. I'll give you a couple examples:


Individual A Stats:  AGI: 1,000,000  Deductions: $200,000  Taxable Income: $800,000


Total Taxes/Rate On Full Income With No Deductions:  $326,761/32.68%
Total Taxes/Rate As Currently Structured With $200,000 Deduction: $256,761/25.68%
Total Taxes/Rate In The Progressive Deduction Model: $272,232.50/27.22%


The Methodology Of The Progressive Deduction Model: $200,000 (the amount of the deduction) falls in the 33% tax bracket of $178,650 – $388,350.  Therefore, the filer would pay the first $388,350 of their taxable income in this bracket and as normal pay 35% on the rest of the $411,650.

Individual B Stats:  AGI: 1,000,000 Deductions: $40,000 Taxable Income: $960,000

Total Taxes/Rate On Full Income With No Deductions:  $326,761/32.68%
Total Taxes/Rate As Currently Structured With $40,000 Deduction: $312,761/31.2%
Total Taxes/Rate In The Progressive Deduction Model: $316,731/31.67%


The Methodology Of The Progressive Deduction Model: $40,000 (the amount of the deduction) falls in the 25% tax bracket of $35,350 – $85,650.  So the filer would pay the first $85,650 of their taxable income in this bracket.  Then they would follow the brackets as normal.

In each of these examples the millionaire paid a slightly higher effective tax rate in the Progressive Deduction Model than they currently do, but without raising the top marginal rate, imposing a surtax, or ending/capping deductions.  While it would minimize the impact of deductions for the wealthiest, it wouldn't do so in such a way that it would seriously deter things like charitable giving.

I don't want people to think this is a cure-all to the problems of tax inequality. There are so many problems that need to be addressed I could blog forever on the subject (and just might).  This just seems like a reasonable step that could be taken to get us (however slightly) closer to the goal of fairness in our tax system. 

One other note:  I am not an economist.  If anyone who reads this sees problems with my methodology, or wants to praise it, please do so in the comments section.