I. Introduction: “You Can Observe a Lot by Watching”
The Internal Revenue Code is the single most comprehensive statement of policy in American law. It suggests the best ways to make and spend our income, and how we spend our income defines who we are. It affects any person who has income. Taxpayers who have the wherewithal to take up the Code’s income tax liability-reducing suggestions help to “mold” the fabric of much of American society. For those without the wherewithal to take up the Code’s tax liability-reducing suggestions, the Code functions to perpetuate an unequal distribution of advantages. It should be obvious that the tax benefit afforded to one taxpayer or group of taxpayers will increase the tax burden of other taxpayers if we expect the income tax to raise a certain amount of revenue. Nothing is free, and those without the wherewithal or desire to make tax liability-reducing expenditures pay for the taxes on the untaxed choices of the taxpayers who make them. Adoption of the Tax Cuts and Jobs Act (TCJA) in December 2017 removed many taxpayers from the rolls of those able to itemize deductions, and in so doing, established high-income taxpayers as the only ones who should have the privilege to make those tax liability-reducing choices that are inherent in itemized deductions and denied the privilege to many millions more. These deductible tax liability-reducing choices represent “votes” for the type of society we want. The TCJA will hasten the changes in American society already occurring, and not necessarily for the better.
Taxpayers determine their tax liability according to a “tax formula” derived from sections 61, 62, and 63 of the Code. A taxpayer determines his or her tax liability by (1) adding together all items of gross income, i.e., accessions to wealth (section 61), (2) subtracting the deductible expenditures named in section 62 to determine an “adjusted gross income” (AGI), (3) subtracting either the taxpayer’s itemized deductions or a standard deduction, (section 63(b)(1), 63(d)), and post-TCJA (4) subtracting any “qualified business income amount” (QBI) deduction (sections 63(b)(3), 199A). The taxpayer then computes his or her income tax liability, applying rules applicable to certain types of income and using indexed brackets applicable to so-called “ordinary income.” Those brackets do not apply to a taxpayer’s “net capital gain.” Until 2025, section 1(j)(5) establishes a “maximum zero rate amount” and a “maximum 15-percent rate amount” to determine whether a taxpayer’s net capital gain plus qualified dividends will be subject to a tax rate of 0%, 15%, or 20%. “Net capital gain” and “qualified dividends” are subject to tax rates that are slightly more than half the tax rates applicable to “ordinary income.” Then (5) the taxpayer may reduce his or her tax liability by any credits available. Every mathematical operation after tallying up gross income (except for computation of the tax itself) is a subtraction, to wit: adjustments to gross income, standard or itemized deductions, QBI deduction, and credits. These subtractions from taxable income or tax liability reflect congressional judgments that taxpayers who incur certain expenses or derive certain types of business income should be accorded a “tax benefit.”
A neutral tax code would not influence a taxpayer to prefer one expenditure over another. By adopting tax measures that do influence taxpayers to make certain expenditures, Congress has willingly sacrificed neutrality in favor of such influencing and, as a result, has done much to allow the Code to mold the fabric of American society. The TCJA, by suspending or limiting various deductions through the end of 2025, might appear to move the Code towards greater neutrality.
It did not. Rather, the TCJA restricts the availability of itemized deductions that reduce a taxpayer’s income tax liability to high-income taxpayers and rewards taxpayers for owning successful businesses above and beyond the profits a market economy already provides to such winners. The rich will get richer while others will not, and they will have more and cheaper votes in determining the type of society we will have.
This availability of certain tax benefits to some and their unavailability to others have had profound effects on the fabric of American society, often sub silentio reenforcing patterns of invidious racial, economic, and social segregation. Individual taxpayers probably do not believe that their choices help to mold the fabric of American society. Rather, they see their choices as affecting only their own tax liability, and naturally, would prefer to reduce such tax liability as much as possible. But of course, individual taxpayers’ choices do make such contributions.
Taxpayer’s tax-reducing choices cumulatively favor all those taxpayers who make the same choices—at the expense of entire groups who do not and perhaps cannot make a tax-reducing choice. Professor Joel Slemrod observes:
With very few exceptions, modern tax systems do not base tax liability on the group identity of the taxpayer, be that race, religion, gender, or other characteristic—there is no explicit discrimination. But effective differentiation of tax burden by group membership can be achieved without explicit discrimination if tax liability depends on choices or circumstances that are characteristic of group members. Modern taxes are not lump-sum, and, as such, choices drive tax liability. This is obvious in the case of excise taxes, where those who consume relatively more of a taxed good or service bear a higher burden, other things equal. However, it is also true of income tax systems that typically contain scores of provisions that reward or penalize households based on their choices and circumstances.
Pre-TCJA, taxpayers learned to game the rules to the extent they were able. The ones not so able paid more than those with otherwise comparable incomes. The TCJA has changed the rules of the game. Taxpayers will quite predictably game the new rules so as to reduce their income tax liability.
In evaluating the TCJA’s changes, this Article adopts this straightforward rubric: Does a change to the Code’s itemized deductions make our society better? A change should impel those who would reduce their income tax liability through itemized deductions to make society better.
More divisiveness on the lines of race, economic well-being, and social and cultural lines do not make our society better absent some as yet undefined offsetting benefit. Greater concentration of wealth among the already wealthy (and that greater concentration’s accompanying greater inequality) is not better. Decreasing progressivity or increasing regressivity, or both, is not better.
Backers of the TCJA who will argue that its temporary measures should be made permanent should bear the burden of showing that its changes will produce a net improvement to our society. They have yet to do so.
For cohorts of lower-income taxpayers, the standard deduction naturally constitutes a greater portion of their income than it does of higher-income taxpayers who itemize. They therefore derive a proportionally greater benefit from the standard deduction than higher-income taxpayers do. The income tax-reducing expenditures that they may have the wherewithal to make must either reduce their adjusted gross income (AGI) (i.e., through deductions named in section 62) or entitle them to tax credits. Many above-the-line deductions and creditable expenditures are subject to income phaseouts and so to that extent do not benefit higher-income taxpayers.
Section 62’s adjustments to gross income (i.e., “above-the-line” deductions) are to a considerable extent allowed for incurring the expenses of earning income not derived through ownership of a business, shifting the income tax burden associated with earning income to the time such income is used for certain forms of consumption, incurring expenses that should reduce a taxpayer’s income tax liability but will not because such taxpayer’s deductible expenses will not exceed the standard deduction, and incurring expenses that pursue policies bigger than the interests of a taxpayer (e.g., costs of discrimination suits, attorneys’ fees of whistleblowers). For high-income taxpayers who itemize, section 62 is not so important. Section 62 grants a taxpayer only a little discretion whether or how s/he will or should incur expenses that adjust his or her gross income, and as section 67(g)’s suspension of “miscellaneous itemized deductions” illustrates, that discretion is revocable.
Itemized deductions, on the other hand, can reduce a taxpayer’s income tax liability for expenditures over which taxpayer has considerably more discretion, e.g., charitable contributions to advocacy and policy-oriented educational-purpose organizations (section 170(c)(2)(B)), home mortgage interest deduction (section 163(h)(2)(D)), and state and local tax (SALT) deductions (§ 164(a)(1, 2)). In addition, high-income taxpayers benefit from the lower tax rates applicable to their net capital gain income. For taxpayers who derive a sizable portion of their income from net capital gains and qualified dividends, a lighter income tax burden on such gain is equivalent to an invisible deduction from ordinary income. Tax benefits for high-income taxpayers can be in the form of a lower tax rate or a reduction of taxpayer’s “taxable income.” The result is the same.
For taxpayers in higher (but not only the highest) income segments, the Code pre-TCJA fashioned a large class of “aspirational” taxpayers, i.e., taxpayers who aspired to own homes, to educate themselves and/or their offspring, to contribute to charity, and to retire comfortably. The Code reduced their income tax liability relative to the income tax liability of other taxpayers because they “voluntarily” used their income to invest in such aspirational objectives. They were itemizers who deducted the mortgage interest they paid to borrow money to purchase their home, the property, income, and (in some states) sales taxes they paid to state and local governments, and the contributions they paid to charities. They were part of President George W. Bush’s “ownership society” and the ideal taxpayers. Pre-TCJA, the government collected more from a nonitemizer than it did from an aspirational itemizer with the same adjusted gross income. A sufficient number of taxpayers could respond to the Code’s incentives so that a certain type of society emerged. There might be consensus that such a society of homeowners living in stable neighborhoods was the best among all the alternatives. No longer. The TCJA doubled the standard deduction so most of these aspirational taxpayers no longer itemize. Now, the government will collect the same amount from both the pre-TCJA (and no longer) itemizer and the never-was itemizer with the same adjusted gross incomes. Rate reductions coupled with increases in the ranges of incomes subject to each increasing bracket prevented most taxpayers’ tax bills from increasing, even as the tax bills of many taxpayers decreased relative to those of other taxpayers. It seems that most taxpayers did not notice (or did not complain) about this.
When the standard deduction increases, the size of the class of taxpayers who benefit more from claiming the standard deduction rather than itemization increases. The TCJA doubled the standard deduction. The expenditures for which large cohorts of taxpayers no longer reap income tax benefits relative to other taxpayers through itemization are increasingly trivialized insofar as shaping the American home-ownership society is concerned. Perhaps that is good, but it should not be ignored. This Article presents some random musings about the TCJA provisions that together will help to change the fabric of American society. Post-TCJA, the Code may help to fashion a class of “business owner” or investment taxpayers, especially business owners who manufacture things, preferably for export, and investors who invest in and hold property beside their homes. This class will be smaller than the “aspirational class.” Should the members of this class so choose, their deductible expenditures can easily pass the threshold of itemization through payments of mortgage interest to service hefty borrowing to acquire a home, of $10,000 of state and local taxes, and of charitable contributions. And irrespective of whether members of this class can itemize, they can direct more of their expenditures to business profit, and their tax liability will decrease further relative to other taxpayers solely because they are profitable: the more they profit, the more they can reduce their taxable income. They will also invest in growth securities and thereby defer tax liability on their investment income (or at least allow it to compound it at preferential tax rates), perhaps forever. Taxpayers with the wherewithal to generate more of their income as “net capital gains” generally begin with more wealth, and they have considerable discretion in how they generate such gains. The result of these trends will be an effectively less progressive (perhaps even regressive) tax code. And as the rich alone get richer while others do not, inequality and the manifestations of it will increase.
This Article focuses on the aspirational and business owner classes of taxpayers. It focuses on taxpayers who do (or did) have the wherewithal to respond to the tax liability-reducing choices inherent in the Code. The merely aspirational taxpayer no longer responds to the Code’s blandishments to shape American society because the Code’s emphasis has changed. “Votes” of the aspirational class will no longer be so meaningful. The business owner or investment class of taxpayers will be the only ones able to respond to the Code’s blandishments to help determine the type of society we have. The Code’s changing emphasis has occurred not through wholesale redefinition of existing provisions, but through increases, decreases, and limitations on existing and well-defined deductions and exclusions, as well as through overt handouts of tax benefits to a certain class of successful (i.e., making a lot of income) taxpayers solely because they were successful. The Code now gives tax benefits to nonservice provider business owners, service providers with effective lobbyists, and real estate investors. Employees and most other service providers are not so favorably regarded. The Article observes that there are consequences to this and also argues that to the extent Congress wishes to pursue policy through the Code, including investment policy, it should do so through tax credits rather than itemized deductions. This would give more taxpayers a “vote”—re-enfranchising them—in determining the type of society we have and reverse the trend toward regressiveness in the Code.
II. The Internal Revenue Code, Tradeoffs, and Burden Sharing Among Economic Classes
U.S. governments—federal, state, and local—raise most of the revenue necessary to operate through taxes. We consider here mainly the federal income tax, but there are payroll taxes, sales and excise taxes, and property taxes, to name a few others. Those who choose which taxes to use to raise revenue implicitly determine the capacity of a government to accomplish things. Low tax revenues may result from low rates of tax or from a determination not to mulct a particular tax base from which such revenue could be raised. And higher taxes imply the opposite. Choosing to collect little in tax revenues implies a determination that a government will not provide services that another government might feel a greater compulsion to provide. Adoption of the TCJA manifested a choice to make the federal government smaller and less responsive to felt needs because it will raise less revenue than the pre-TCJA Code. Its cap on the SALT deduction also implies smaller state and local governments.
Moreover, the capacity of one type of tax to raise revenue depends on whether the tax is imposed on those with sufficient capacity to pay it. Choosing a tax that is regressive (or regressive in effect) will require that those with less wherewithal pay a larger share of their wherewithal to raise a certain amount of revenue than a tax that is progressive in effect. A flat tax on consumption, such as a sales tax, may appear to be fair, equitable, and equal—but its effect is likely regressive. High-income taxpayers can afford to save and so do not pay the consumption tax on all their income. For low-income taxpayers who cannot save, the opposite is true. State governments that choose to rely (mostly) on flat consumption taxes will, over time, perpetuate economic stratification and limit what they can accomplish—all other things being equal. Those effects will have a particularly pernicious effect on racial minorities because they are the most economically disadvantaged. For at least some state legislatures, this pernicious effect seems not to matter.
Every choice concerning whether and what to tax imposes the opportunity cost of forgoing one or more alternatives, i.e., there are tradeoffs. A “big, beautiful tax cut” is not costless. On a system-wide level, someone’s “big, beautiful tax cut” will cost someone else—whether as an increased tax burden, as a reduced benefit, or as some other reduced expenditure (e.g., national defense, infrastructure investment). Fairness requires that the proponents of reductions in income taxes identify that “someone.” The rationale for cutting social programs after choosing to reduce tax revenues that “we just don’t have the money” is not a rationale for such cuts, but a manifestation of a choice no longer to raise the necessary revenues from those who would have to pay. The statement that Congress and the President chose to give tax cuts to the wealthiest Americans at the expense of those least able to pay is a far more accurate description of relevant tradeoffs than the vacuous statement that we all deserve tax cuts.
Tax legislation is policy legislation, and policy legislation manifests judgements about fairness. This is certainly true of the income tax—as through measurements of gross income, exclusions from gross income, adjustments to gross income, and itemized deductions we determine the legislatively-approved appropriate amount on which to assess an individual taxpayer’s income tax liability. Determination of the appropriate tax bracket to be applied to increments of taxable income manifests another judgment. Credits against tax liability manifest judgments about the choices taxpayers make or their personal situations that entitle them to such credits. The Code distinguishes taxpayers from each other through the allocation of such benefits and burdens. Those distinctions may be, at least arguably, inappropriate.
Professor Linda Sugin’s early identification of the choices that Congress has made in the Code (and elsewhere), including through the TCJA, are the following:
- The best family is the “traditional” family, i.e., married taxpayers, especially those with children;
- Individuals are entitled to keep more of their income derived from capital than from labor;
- The best taxpayers are autonomous individuals, not dependent on employers;
- Charity is the domain mainly of the rich; and
- Physical things are important.
These seem to reflect explicitly the core values of the TCJA. Implicit values are that racial and economic inequality should be enhanced and that wealth is insufficiently concentrated. Wealthy taxpayers deserve to keep their wealth in their families, even after they die. Neighborhoods should be racially and economically segregated. Wealth begets wealth; greater inequality is acceptable.
Since the time of Ronald Reagan’s presidency, the prevailing—that is to say, it prevailed—wisdom is that supply side tax cuts spur investment, especially among the wealthy, and thereby spur growth that leads to higher employment and higher wages. Tax cuts lift all boats. In the case of the TCJA, the tautology fails—likely at the first step—spurring investment. The TCJA’s tax cuts as policy have failed to lift all boats. The damage done—racial and economic inequality, wealth concentration—has outweighed the gains that could be attained in no way other than supply side tax cuts.
A certain amount of inequality results from a vibrant, competitive, and innovative economy. Innovators (and the investors who supported them) profited from the advances they brought to market that have made our lives better. They deserve more wealth than the rest of us. But a tipping point has been reached. Concentration has increased, but societal benefits have not kept pace. Untoward consequences (e.g., increasing crime, distrust of institutions, political instability, health issues) have resulted. Amendment of the Tax Code ought not to accelerate the concentration of wealth and worsen inequality. But the TCJA does just that.
Society is now divided and segregated along racial, economic, educational, and cultural lines. Inequality has grown to unhealthy levels. Nevertheless, many people find a place, a niche, within the social construct that the Code implicitly endorses, largely oblivious to the consequences that befall others. Each pursues one or more American dreams, whether home ownership, education, a comfortable retirement, or pursuit of ideology. For many years, the Code has supported the pursuit of these dreams with subsidies from those who did not or could not pursue them. The ones for whom the Code provides no subsidy for their choices are invariably ones who are racially, economically, and educationally disadvantaged. Whether by accident or design is irrelevant.
Inequality across generations of course creates a different starting point for everyone. Those who were born with a “silver spoon in their mouth” may work hard—and achieve much. They benefit from a widespread belief that they earned and deserve all their wealth and position and should not be accountable to those less high-born. They work hard, but there is a circularity to their claims of just desserts. And once they have such wealth, they will spend up to the amount of their wealth to keep it. A person will spend nine to save ten. Some have the capacity to spend enormous amounts to influence those in power—or to become those in power—to preserve their wealth. They may do this in the name of charity so that other taxpayers pay for supporting the causes of those with wealth. Or they may more crassly (and often secretively) spend to preserve their wealth.
The TCJA was big, but not beautiful. Its tradeoffs will not improve the fabric of American society. This Article now turns to the impetuses that the Tax Code created pre-TCJA and post-TCJA to create certain dreams and preferences. We have ostensibly moved from the creation of an aspirational society to the creation of a business owner-investment society.
III. Itemized Deductions: Ditching the Aspirational Class to Benefit the Business Owner-Investment Class
Pre-TCJA, the Tax Code, through itemized deductions, distinguished horizontally mainly among:
- homeowners and renters,
- those who paid (a lot of) state and local property, income, and sales taxes—and those who did not, and
- those who made contributions to charity and those who did not.
The aspirational class benefitted from these distinctions relative to those less aspirational (or whose aspirations were less “conventional”) and relative to those with less means. Notably, members of the aspirational class could reduce their taxable income by the cost of borrowing money to purchase their personal residence, paying state and local taxes, and contributing to charity. There may have been little reason to prefer that the Code make these distinctions rather than other distinctions or even no distinctions, but taxpayers qua consumers over many years responded to the prods these distinctions created to maximize the value our economy could create within the parameters of these rules. If the focus of the Code’s distinctions should change, we should have some assurance that such change leads to an actual improvement.
The TCJA effectively jettisoned the aspirational class in favor of a nonprofessional class of business owners or investors who own homes and rear children without addressing—indeed exacerbating—the invidious discriminations of the pre-TCJA Code. Post-TCJA, the Tax Code through itemized deductions distinguishes vertically only between very-high-income taxpayers and everyone else. It also makes distinctions among the high-income taxpayers. The magnitude of these distinctions depends on the amount of the standard deduction and so the filing status of a taxpayer. Because the standard deduction amounts decrease from the filing status of married filing jointly to head of household to single, while the caps on the itemized deductions considered herein are the same for all taxpayers irrespective of filing status, the magnitude of these distinctions can increase from married filing jointly to head of household to single.
Horizontally among very-high-income taxpayers, the Code post-TCJA through itemized deductions distinguishes between taxpayers who make substantial charitable contributions and those who do not, and between taxpayers who are purchasing homes in a certain price range and those who are not. Very-high-income taxpayers cast consumer votes for their lifestyle choices and causes that only they can afford, and the post-TCJA Code rewards them and only them through itemized deductions. Pre-TCJA, the Code ostensibly offered the same incentives to a much larger cohort of taxpayers who aspired to have their wealth configured in ways the Code seemingly encouraged. The aspirational class was able to participate in a certain type of democratic process—voting with income not subject to income taxation on the aspects of American society that could be shaped by such expenditures. After the TCJA increased the cost of such participation by doubling the standard deduction, many in the aspirational class have been disenfranchised. Post-TCJA, the highest-income earners will benefit from charitable contribution deductions more than any other taxpayers and may feel entitled to mold the fabric of American society through their generosity. “[B]ecause of the TCJA, the wealthy generally receive government support in their efforts to exert disproportionate control over society, while those with lower incomes who have a greater need for government support in order to affect society, are generally not given it.” “By limiting the itemized charitable deduction primarily to the wealthy, the government is supporting the wealthy’s efforts to shape civil society . . .” Society will become less pluralistic. This is not an improvement.
The business owner or investment class is a much smaller cohort of taxpayers than the aspirational cohort—and comprised of the highest of income earners. Beyond what members of this class need to be a part of the aspirational class, these taxpayers seek wealth through ownership of capital assets. This class benefits from lower tax rates on capital gains than on ordinary income, and deferral of recognition of gains. The lower income tax rates on net capital gains assure that this class does not need to derive tax benefits from home ownership to enjoy tax benefits of comparable magnitude. Of course, these benefits are still available to them should they wish to exploit them. Because this class derives income from the ownership of property and the nonrecognition of unrealized gains, the income of this class can compound faster than it can for others, thereby exacerbating inequality among the classes identified here. This class can compound these gains further by adopting the strategy of “buy, borrow, die.”
By taking advantage of such benefits, taxpayers as a whole help shape the productive aspects of our economy and determine the availability and quality of the things that money can buy of which Congress sufficiently approves to provide a tax benefit. The facially neutral language of the Code presumes that all its provisions apply equally to all taxpayers, and that all taxpayers can voluntarily take advantage (or not) of adjustments to gross income, itemized deductions, the qualified business income deduction, and tax credits. All the while, we know that only those with a certain amount of income are well-positioned to borrow substantial sums to purchase a personal residence, to spend substantial sums on a cause in which they believe (whether or not charitable), to spend substantial sums on what they believe to be worthy culture, to spend their income purchasing capital assets, or to spend income on approved retirement vehicles. The purchasing decisions of the highest-income earners do much to determine the availability and quality of such tax-favored things as housing, educational institutions, culture, and even political thought. The highest-income earners now cast disproportionately less expensive votes than others cast.
We are admittedly omitting lower-income-never-were-itemizer taxpayers from consideration. Irrespective of provisions of the Code, such taxpayers will not have the wherewithal to make deductible income tax liability-reducing expenditures, e.g., paying interest on a home mortgage, paying state and local taxes, making sizable charitable contributions, paying sizable medical expenses. The pecuniary cost to them of forgoing tax-liability-reducing choices is less because their tax bracket is lower than the tax bracket of higher-income taxpayers. If the standard deduction is more than the amount the taxpayers in this class of taxpayer spend on such tax-favored items, they derive a greater benefit from taking the standard deduction than if they had itemized. For this group, the benefit of the standard deduction is available even if their expenditures on such items are $0. This is a truism for any nonitemizing taxpayer. However, the TCJA took the privilege of itemization from a sizable cohort of middle bracket taxpayers; i.e., it disenfranchised them.
And so, the focus turns to the one-time but no-longer itemizer.
IV. The TCJA: Moving Towards Neutrality and Arriving Further from It
Perhaps the best of all possible income tax codes is one that is neutral in that it does not influence taxpayers to make certain decisions. The argument is that taxes, at least the income tax, should serve no purpose other than to raise funds necessary to enable the government to function. The Code should neither reward nor punish taxpayers for the choices they make with respect to how they earn or spend income. Professor Boris Bittker addressed this pipe dream many years ago.
In theory, a “neutral” income tax code would impose an income tax on “all” taxable income and allow no deductions or exclusions other than for the cost of earning the income. The same tax rates would apply irrespective of how a taxpayer derived income. In such a world, taxpayers as consumers would make their purchasing and earning choices without any concern for the tax consequences of their choices. Taxpayers’ purchasing choices would truly reflect the relative after-tax values they as consumers (and as a collective whole) place on items of consumption (or saving). This would lead to productive and allocative efficiency. Producers of goods and services would be rewarded most by being productively efficient, i.e., deriving the “most bang for the buck.” Consumption and production choices would distribute wealth in a way that maximizes the value that our nation’s economy generates, i.e., allocative efficiency. But, alas, the Code is not neutral. It will always be an instrument that Congress uses to pursue policy. Tax neutrality is not possible.
Any deviation from a “neutral” tax code to some extent compromises either productive efficiency, allocative efficiency, or both. Any exclusion, deduction, or credit furthers a particular policy, and Congress must implicitly value that policy more than either productive efficiency, allocative efficiency, or both. Once a policy is in place, the economy will move to maximize value within the constraints of deviations from neutrality that the policy entails.
Taxpayers who avail themselves of itemized deductions in essence receive a discount for making congressionally-favored purchase and investment choices that nonitemizing taxpayers do not enjoy. Deductions (or exclusions from gross income) from taxable income for personal expenditures—i.e., not those for ordinary and necessary trade or business expenses—have historically pursued some combination of four fundamental objectives that Congress implicitly endorsed. The Tax Code makes pursuit of most of these objectives voluntary in that no one is compelled to incur the expenses of pursuing them.
- Congress may grant taxpayers a tax benefit, whether by deduction or exclusion, because we are willing to permit taxpayers to exchange some current consumption for future consumption, e.g., pensions, medical care (health savings accounts), education. That future consumption might be subject to income taxation at the time it occurs. The fact that taxpayers willingly make these exchanges assists them in making certain expenditures that government—whether federal, state, or local—might otherwise feel a need to help them make. In these cases, the Code creates a consumption tax rather than an income tax.
- Congress may permit deductions or grant other benefits to encourage taxpayers to make investments that will enlarge the tax base, i.e., investments in increasing taxable income, e.g., expenses of moving to a better job, education expenses, dependent care expenses.
- Congress may permit deductions because a sense of fairness—whether or not misplaced—requires that taxpayers who have no meaningful choice but to make certain expenditures should not have to bear those expenses from their after-tax income, e.g., medical expenses, casualty loss expenses.
- Congress may permit deductions because taxpayers make expenditures that permit them to contribute to the building of a society that we as a nation implicitly want, e.g., charitable contributions, especially to so-called “A” charities, home mortgage interest deduction, SALT deductions. Such expenditures encourage voluntary expenditures (i.e., consumption) that benefit the greater society.
A tax preference should not reduce overall societal value in the tradeoffs that it requires. Only two of these rationales stand up to the scrutiny such a standard implies. Of the four broad purposes of deductions, exclusions, and credits—only two do not perforce require other taxpayers’ subsidization: taxing income at a more appropriate time (i.e., time of consumption rather than currently) and investing in enlarging the tax base. This claim is based upon the ideal that a tax preference should not reduce overall societal value through the tradeoffs that it requires and that mandating taxpayer subsidization of others’ choices will likely reduce overall societal value. Consider each of these four objectives:
Exchange current for future consumption: The Code permits taxpayers to exchange current consumption for particularized future consumption. The taxpayer implicitly values that future consumption more than current consumption. Upon that future consumption, such consumption may or may not be subject to income tax. Such exchanges may give the taxpayer the opportunity to exploit the time value of money because the deferred income is (apt to be) subject to a lower rate of income tax than what it was when originally realized. Examples include health savings accounts (sections 223(d), 106(d)), qualified tuition plans (section 529) and Coverdell Education Savings accounts (section 530), individual retirement accounts (sections 219/62(a)(7)), and other retirement vehicles (sections 401(k), 403(b), 457, etc.). These provisions also help to smooth the timing mismatch otherwise occurring between income and expenditures. Such exchanges should be encouraged, so long as the choice of spending objectives and the income tax treatment of the future consumption are appropriate for the particularized expenditure—whether income tax, exclusion, or shifting the tax burden to another.
Enlarging the tax base: Congress gives some income tax benefits because taxpayers incur expenses that (potentially) enlarge the income tax base. Such benefits include credits for child and dependent care (section 21), education credits that phase out (section 25A), and deductions for education loan interest that phase out (sections 221/62(a)(17)). Pre-TCJA, taxpayers who incurred qualified moving expenses (section 217/62(a)(15)/132(g)) to move to the locale of another job might encourage them to seek better employment opportunities. These tax benefits are beneficial because they increase the income-earning potential of taxpayers and therefore the income tax base.
The TCJA suspended the Code’s moving expense provisions. That suspension creates barriers to seeking better employment for lower-income persons who must work in-person during the pandemic. Many higher-income persons learned that they could work via Zoom and other remote working tools and, thus, did not need to move to keep their jobs. Restoring tax benefits for moving expenses in 2026 should take the form of a phase-down (or even a phase-out) based on a taxpayer’s income for moving expenses. The TCJA also did not increase the child and dependent care credit (section 21), a credit that is limited in amount, available for only two children, not indexed for inflation, and which Congress has not increased since 2001. It also did not increase the maximum exclusion for employer-provided dependent care assistance programs (section 129). The pandemic was the driving force that spurred Congress to address temporarily these omissions. Congress should have done more in the TCJA to enlarge the income tax base, particularly among those with lower incomes.
“Unfair” burdens: We naturally feel that tax expenditures should truly result from the exercise of meaningful choices. High medical expenses and casualty losses are two costs that we implicitly feel taxpayers should not have to bear without help from other taxpayers because taxpayers do not incur them through meaningful choices. Perhaps. However, insurance markets are such that there are, in fact, very few disasters that taxpayers cannot protect themselves against financially. Moreover, taxpayers’ behavior or consumption choices might increase or decrease the risk that such expenditures might one day be “necessary.” There is an element of moral hazard in one’s choice to smoke or to build a home in a flood plain or in a “tornado alley.” Pre-TCJA, casualty loss deductions perforce required that all taxpayers support those without the prudence to insure themselves against risks that they, at least in some manner and to some degree, willingly incurred. This reduces overall societal value. As for the medical expense deduction, the TCJA lowered the floor of medical deductions from 10% of AGI to 7.5% of AGI—a provision likely to help mainly high-income taxpayers more than anyone, as they are the ones most capable of exploiting the medical expense deduction. (Other taxpayers either have health insurance and do not have the wherewithal to incur noncovered expenses or do not have deductions of sufficient magnitude to itemize.)
The society we want: Between sections 102, 107, 163(h), 164,42 and 170, we can discern that Congress wants a society of generous, spiritual homeowners who live in good neighborhoods, and give money to charity. They work for employers who provide them and their families with healthcare (sections 106, 105) as well as other benefits for which there is a good fit between what employees want and what employers can provide (sections 129, 132, 127, 125, 79). There is hardly universal agreement in a country of 330 million people that all these are values that we should implicitly support at the expense of those not in accord. Moreover, some taxpayers lack the wherewithal or the desire to make some or all of the expenditures that such Code provisions require in order to receive the tax benefits they provide. Such taxpayers therefore implicitly subsidize those able and willing to make such expenditures. Such cost or tax liability shifting results in an overall loss in societal value in that costs are usually shifted away from those better able to pay to those less able to pay.
Comment: Particularly insofar as the Code helps to sculpt our society, there is for the most part nothing to compel the conclusion that its pre-TCJA objectives and policies are better than others and are ones for which those who do not make such voluntary expenditures should have to contribute. Those who do incur such expenses—like an invisible hand—cause our nation to pursue policies and shape our society at a price discounted by the amount of the expense multiplied by the responsive taxpayers’ marginal tax brackets. To the extent that fewer taxpayers can make such choices, the TCJA has made (or will make) pursuit of these policies the exclusive domain of high-income taxpayers.
The voluntariness of this form of participation in our democracy depends upon a meaningful opportunity to reduce income tax liabilities through itemization. In doubling the standard deduction, the TCJA cut the number of itemizers by 62.6% so that in tax year 2018, only 11.4% of individuals itemized deductions; in 2017, that figure was 30.6%. Taxpayers for whom itemized deductions are available are the ones who can (and may) voluntarily serve congressional ends. Remaining taxpayers can pursue those ends only at prices considerably higher than those paid by itemizers.
The rich are different; they have more money. If it was not plain before, the TCJA cemented in place a perception that the rich (i.e., those with high incomes) are indeed different. They derive income differently. They spend (i.e., consume) differently. They are taxed differently. Itemized deductions and tax-deferral are for the wealthy. Deductions for high-bracket taxpayers are the most expensive of the tax tools that Congress wields simply because their brackets, i.e., the multipliers, are the highest. Much discretion is inherent in their itemized deductible spending. On the other hand, adjustments to gross income, exclusions, and tax credits are allowed only for spending that is directive and specific.
With respect to itemized deductions, the facially neutral Code has discriminatory effects that other federal laws would prohibit if pursued deliberately and directly. These discriminatory effects perpetuate invidious discriminations, if not cause them. Of course, every taxpayer can contribute to the objectives that Congress ostensibly pursues through the Code, but very few will derive any tax benefit from their contributions relative to those who do not make such expenditures. The few who do—those in the high tax brackets—will derive outsized benefits, both because those in the lower brackets are squeezed out of this form of democratic participation and because their higher tax brackets ipso facto provide them with greater benefits. Their choices are not more worthy than others’ choices—particularly when their good fortune results from unequal opportunities.
Because the TCJA doubled the standard deduction and flattened tax brackets, most taxpayers who were itemizers will not see their taxable income tax liability increase, but they will see a “levelling down” of themselves with those taxpayers who never did itemize. The great majority of taxpayers no longer participate in the de facto voting that the Code previously enabled them to do. The TCJA moved the Code further from neutrality than the pre-TCJA Code and exacerbated inequality among taxpayers. This is not better than the pre-TCJA Code.
