As the latest attempts to repeal the Affordable Care Act have recently failed, it seems that Congress is moving on to the next item on their agenda: tax reform. I guess that’s why I keep stumbling on articles suggesting drastic changes to the tax code: like eliminating the mortgage interest deduction.
My main beef is not with any specific deduction in our tax code. (Though the mortgage interest deduction is curious, to say the least.)
Rather, I think our system of deductions runs counter to the goals of our progressive income tax system itself. Looking at most of the incentives, the more you earn, and the more tax you pay, the more you benefit from the programs.
Let’s take the 401k, for example. Anyone making up to $270,000 annually, from the humble custodian making minimum wage to the corporate attorney pulling in a quarter million in salary, can contribute the same amount: $18,000. That $18,000 is shielded from federal income tax.
Our attorney in the 33% marginal tax bracket has a strong incentive to save for retirement: putting in the full amount into his 401k would avoid $5,940 in federal income tax alone (and potentially much more, depending on what kind of match his company provides). He potentially avoids quite a bit more in state income taxes as well by saving for retirement, depending on where he lives.
But our custodian’s incentives are much weaker. Assuming that he works 40 hours a week for all 52 weeks a year, his gross pay is only $15,080: well short of the $18,000 annual limit for 401k contributions. After accounting for the standard deduction and the personal exemption, our janitor still has $4,680 in potential taxable income, to be taxed at a 10% rate. So instead of avoiding 33 cents of tax for every dollar invested in retirement