	Introduction

The President and some leading Members of Congress have indicated that income tax reform is a major policy objective. The major itemized deductions are for mortgage interest, state and local taxes, charitable contributions, and medical costs. Reducing incentives and subsidies that alter taxpayers' choices is one potential objective of tax reform. For a given revenue target, tax reform can involve a trade-off between a broader base and lower rates. For an introduction to tax deductions, see CRS Report R42872, Tax Deductions for Individuals: A Summary , by [author name scrubbed]. For general tax data analysis on itemized tax deductions, see CRS Report R43012, Itemized Tax Deductions for Individuals: Data Analysis , by [author name scrubbed]. Detailed tables showing the number of claimants and the size of deductions for each type of itemized deduction are shown in Appendix A . These restrictions could be justified in several different ways, including
to increase federal revenue; to allow a reduction in statutory tax rates, while holding revenue constant; to reduce economic distortions, where individuals pursue economic behaviors that they would not otherwise do, absent the influences of tax policy (also referred to as inefficiencies ); to increase the progressivity of the federal income tax (an issue of vertical equity ); to reduce discrepancies in the taxation of individuals with similar abilities to pay taxes (also referred to as horizontal equity ); or to simplify the tax code. Effects of Base-Broadening on Marginal Tax Rates, Labor Supply, and Saving

The increasing attention to across-the-board proposals for itemized deductions and, in some cases, other tax expenditures, suggests that the primary focus of base-broadening for some could be the goal of lowering tax rates (or preventing them from rising due to revenue needs) rather than reducing subsidies for undesirable or inefficient activities. It is the EMTR—not the statutory tax rate—that could discourage the supply of labor or savings. Simplification and Administration

One objective of tax reform may be to simplify the tax code. Rather than eliminate itemized deductions, a percentage could be disallowed. An option to choose a deduction for state and local sales taxes in lieu of the deduction for state and local income taxes is part of the extenders, which is temporarily in effect through 2013. On the other hand, some options could result in significant increases in revenue, such as ceilings on the mortgage interest deduction and the floors on the charitable deduction. If deductions rise as a share of income, the implication is that the deduction out of each marginal dollar is growing, and thus the elimination of deductions would increase effective taxation at the margin even in a revenue neutral tradeoff for lower statutory rates. These provisions primarily include deductions for state and local income taxes and charitable gifts. For example, in the tradeoff between ending itemized deductions at the top for a 5 percentage point rate reduction, and a net reduction of effective marginal tax rate of 0.6 percentage points, an estimate that used the statutory rate reduction would produce behavioral effects that are more than 8 times as large as they should be (5/0.6)
Even if a proposal could lead to higher effective marginal tax rates for some tax filers, however, this issue could be of limited importance since most evidence suggests these marginal effects on labor supply and saving behavior are relatively small. Nevertheless, the analysis suggests that tax reform undertaken for the purpose of lowering statutory rates, rather than addressing the particular economic effects of the tax subsidized activities, may not accomplish its purpose. The mortgage interest deduction and deduction of real property taxes are not the only provisions that reduce the cost of acquiring and maintaining a home. Adding a floor to the deduction for charitable contributions is often discussed as one option for reform. The following section of the report analyzes various options to restrict itemized deductions from these two standards of economic equity. Some have proposed to have more revenue raised from higher income classes. In addition to administrative issues, there are also transitional issues.
The President and leading Members of Congress have indicated that income tax reform is a major policy objective. Some itemized deductions are visible candidates for "broadening the base" of the individual income tax and cutting back on tax expenditures and primarily consist of deductions for mortgage interest, state and local taxes, and charitable contributions. The benefits of itemized deductions are concentrated among higher-income individuals, and that is particularly the case for state and local income tax deductions and charitable deductions.
Proposals for addressing these provisions fall into two general classes. One approach could include repealing or restricting all itemized deductions. A different approach would consider each type of deduction and tailor a reform to the particular objectives and merits of the deductions, such as a lower ceiling on home mortgage interest deduction and a floor for charitable contributions.
This report analyzes various proposals to restrict itemized deductions—both across-the-board and individually tailored—using standard economic criteria of economic efficiency, distribution, simplicity, and estimated revenue effects. In particular, this report estimates each proposal's potential to contribute to revenue-neutral reductions in income tax rates and the consequences for economic behavior. For an introduction to tax deductions, see CRS Report R42872, Tax Deductions for Individuals: A Summary, by [author name scrubbed]. For general tax data analysis on itemized tax deductions, see CRS Report R43012, Itemized Tax Deductions for Individuals: Data Analysis, by [author name scrubbed].
Regardless of the class of reform undertaken, for a given revenue target, tax reform involves a trade-off between a broader base and lower income tax rates. One objective of lower rates is presumably to reduce the distortionary effects on labor supply and saving. The analysis in this report, however, shows that this trade-off, with respect to effects on labor supply or saving, may be more apparent than real. Economic theory indicates that the tax rate that should determine the supply responses is not the statutory marginal tax rate but the effective marginal tax rate (EMTR). If part of the earnings of the last dollar is spent on tax exempt uses, then EMTRs are lower, and eliminating these deductions raises them.
It is possible for a revenue-neutral tax reform to have no effect on EMTRs, or even raise them, which, for some, may defeat the purpose of tax reform. Analysis in this report suggests that eliminating itemized deductions would increase the top EMTR by approximately 4½ percentage points but permit a statutory rate reduction in a distributionally and revenue-neutral change by about 5 percentage points. Thus, the net effect of this change is a reduction of ½ a percentage point (a tenth the size of the statutory reduction). Proposals with ceilings could easily raise EMTRs.
A traditional concern of tax expenditures is generally that they distort economic behavior. However, for each type of deduction there are also some justifications, although the magnitude may be in question. The provision that may have the most support from an economic efficiency standpoint is the deduction for charitable contributions.
Some types of tax reform may simplify the tax code, but others can make it more complex. In addition, transitional rules may be needed for the mortgage interest deduction to limit the impact on taxpayers with large mortgages and to soften the potential impact on the housing market.