This report attempts to show how options to broaden the tax base by placing limitations on itemized deductions can potentially work against the expansionary effects of reducing marginal tax rates. The report considers the effects on labor supply and savings (which affects the stock of capital) in turn. The report also analyzes the eventual effects of restricting itemized deductions, along with other base-broadening provisions, such as slowing depreciation, on the capital stock. Labor Supply

The effect of marginal tax rates on labor supply occurs through what economists term the "substitution effect." Effects on investment, where the effective marginal rate is only one input, are examined in the " Capital Stock " section. The remainder of this section estimates effective marginal tax rates and changes in effective marginal tax rates for the following policy options:
Elimination of itemized deductions for state and local taxes Elimination of itemized deductions for charitable giving Elimination of itemized deductions for state and local taxes and charitable giving Elimination of itemized deductions Capping itemized deductions at $17,000 Capping itemized deductions at $25,000
These policy options were chosen to illustrate the potential effects, though they do not necessarily reflect current policy proposals. Conversely, the option to eliminate all itemized deductions results in the largest effect in all cases. Recent surveys of labor supply responses of men indicated that labor supply was largely inelastic. For the work force as a whole, a substitution elasticity of 0.1 to 0.3 was indicated and is reported in Table 4 . In tax reform proposals, these negative effects on labor supply from base broadening would partly offset the positive effects on labor supply from lower marginal tax rates. 1 , 113 th Congress), found labor supply increases ranging from 0.4% to 0.8% for FY2014-FY2023. One is to move to the alternative depreciation system that forms the baseline used by the Joint Committee on Taxation for measuring the benefits of accelerated depreciation. The other two provisions are to depreciate two types of intangible investments, research and development and advertising, over a 10-year period. Repeal of the production activities deduction, which allows a 9% deduction from taxable income for certain domestic production, such as manufacturing. Indexation of interest deductions and payments for inflation. H.R. In addition to firm-level taxes on equity investment that can be compared to the statutory rate, these numbers also provide an overall tax rate that includes the effects of other elements in the tax system: shareholder-level taxes (dividends and capital gains) on corporate equity investments, as well as the tax benefits of borrowing and deducting nominal interest at the firm's rate while only part of this interest is taxed to the creditor. Accelerated Depreciation

The most significant base-broadening provision overall, and in the case of any measure of the effect on the effective tax rate, is the move to the alternative depreciation system (third row of Table 10 ), increasing the overall tax rate by 4.6 percentage points. It may be useful to compare these effects of itemized deduction limits to the effect of lowering the statutory corporate tax rate, which is one of the objectives of tax reform. These findings indicate that tax reform that affects savings and investment is unlikely to have significant effects on growth in capital. A 10 percentage point corporate rate reduction, the tax rate reduction proposed in The Tax Reform Act of 2014 and a common target for proposed tax reforms, would increase the capital stock by 0.4% to 0.8%. Conclusion

The analysis in this report shows that provisions that broaden the base can offset in part or more than offset effects of changing tax rates. The analysis also suggests that the goal of increasing economic growth as part of a revenue and distributionally neutral tax reform may not be easily attainable, a view consistent with the findings of economists considering growth effects of the Tax Reform Act of 1986. Disallowing itemized deductions for state and local taxes increased the rate by 1.69 percentage points, and disallowing all itemized deductions increased the rate by 2.5 percentage points.
One source of interest in a tax reform that broadens the base and lowers the rate is the potential increase in growth, as labor supply and investment respond to lower marginal tax rates. Yet, studies of a signature reform in the past, the Tax Reform Act of 1986, found little effect on growth. The act was revenue and distributionally neutral, which is a goal of some recent tax reform proposals. One reason advanced for the limited effects on growth is that the effects of provisions that broaden the base to finance lower statutory rates increase effective marginal tax rates for some taxpayers.
This report shows how options to broaden the tax base by placing limitations on itemized deductions can potentially work counter to the growth effects of reducing marginal tax rates, primarily through reducing labor supply. It also shows how these effects—along with other base-broadening provisions, such as slowing depreciation—limit the effects on investment and savings and can eventually reduce the size of the capital stock in the economy. The effects on labor supply and the capital stock are considered in turn.
To examine the potential effects of base broadening on effective tax rates facing labor, the analysis examines provisions to eliminate itemized deductions for state and local taxes, for charitable contributions, and for both. It also examines provisions to eliminate itemized deductions altogether or to impose dollar caps ($17,000 and $25,000). Eliminating itemized deductions would raise effective marginal tax rates by almost two percentage points on average and is estimated, using common behavioral responses, to reduce labor supply by 0.2% to 0.6%. These effects are significant compared to projected effects in the Tax Reform Act of 2014 (H.R. 1, 113th Congress), where labor supply was projected to increase by 0.4% to 0.8%. More limited restrictions to itemized deductions result in smaller reductions in labor supply.
Similar to the analysis for labor supply, the potential effects of base broadening on effective tax rates for capital investment are examined. The analysis includes two itemized deduction restrictions: disallowing the deduction for state and local taxes and disallowing all itemized deductions. Eliminating these provisions increases the effective marginal tax rate on business income, interest income, dividends, and capital gains. It also included the effects of three provisions that affect how quickly an investment is recovered. One is to move to the alternative depreciation system that forms the baseline for measuring the benefits of accelerated depreciation. The other two provisions are to depreciate two types of intangible investments, research and development and advertising, over a 10-year period. The analysis also considered repeal of the production activities deduction (which allows a 9% deduction from taxable income for certain domestic production, such as manufacturing) and indexation of interest deductions and payments for inflation.
Moving to the alternative depreciation system had the greatest effect, reducing the long-run capital stock (using a range of behavioral responses) by 0.8% to 1.6%. It more than offset the effect of a 10 percentage point corporate rate reduction. Indexing interest deductions and payments for inflation had the next largest effect, 0.5% to 1.1%. Repealing itemized deductions for state and local taxes reduced the capital stock by 0.1% to 0.2%, and repealing all itemized deductions reduced it by 0.1% to 0.3%. Repealing all itemized deductions offset about a third of the effect of reducing the statutory corporate tax rate by 10 percentage points.
An inevitable characteristic of a revenue-neutral tax reform is a tendency to balance out positive and negative effects on labor supply and growth. Revenue-neutral tax reform may have other virtues, but given the inevitable trade-off of such an approach, a major impact on growth may not be one of them.