Just hearing the words “dependent exemption,” “itemized deductions” and “tax credit phase out” makes most of us want to run screaming to our friendly CPA for help. As policy collides with politics in the tax debate, these concepts have moved to center stage.
An almost universally held principle of good tax reform is the goal of broadening the tax base and lowering tax rates. Easier said than done. The screaming from special interests begins the moment you begin to take away the credits, exemptions, deductions and loopholes.
Critics have raised two primary concerns with Georgia’s soon-to-be finalized tax-reform plan: reduction of the dependent exemption (primarily benefitting families with children) and the capping of itemized deductions.
Both the dependent exemption and itemized deductions are higher in this plan for low- and middle-income families, but decline to zero for the highest income levels. For families making over $200,000 there are no exemptions or deductions — just multiply your income by 4.5 percent. It doesn’t get much more simple than that.
There should be no questions that this proposal is pro-family. In addition to eliminating the marriage penalty, deductions for children actually have increased for most families. In addition to the dependent exemption of $2,000, there also is a $150 per child credit. Added to the $2,000 exemption, that’s the equivalent of more than $5,000 per child and a large increase compared to the current $3,000 exemption. This credit covers more than two-thirds of Georgia’s children before it begins to phase out for incomes above $60,000.
The limits on itemized deductions have raised the ire of numerous interest groups. In the latest proposal, itemized deductions are capped at $22,000 for families with income below $75,000 and $17,000 for families up to $160,000. That covers 96 percent of Georgia’s income-tax filers.
Does $22,000 in itemized deductions cover most low- and middle-income Georgians? Based on data from the IRS, the average mortgage-interest deduction for incomes of less than $100,000 (90 percent of Georgians) is $9,155. The same data shows the average charitable contribution is $3,083 and the average property tax paid is $1,979. That adds up to $14,218, with room for deductions for other taxes paid and higher charitable contributions.
Consider a specific example such as a married couple who both teach. The average Georgia teacher salary is $48,300, so we will assume their total family income is $96,000 and they have itemized deductions of $17,000. They save $601 under this tax-reform proposal.
Every $1,000 in deductions saves $45 at a 4.5 percent tax rate. For the family above, the $601 savings is equivalent to adding an extra $13,000 of itemized deductions (601 / 45 = 13). Adding this to the $17,000 already allowed equals equivalent deductions in the new plan of $30,000. If one of these teachers is promoted to principal, their income easily could reach $150,000. They then would save $1,412 or the equivalent of $48,000 in itemized deductions.
Here is the fundamental difference. Under the current system, the government taxes you unless you document that you spent money in ways the government deems acceptable to deduct. In the proposed system, the government taxes you less (with a lower rate) and allows you the freedom to decide how you spend your
There is a concern that limiting itemized deductions might limit charitable deductions. Ask your favorite charity or your church if their donations are up or down over the last two years. People give more when they have more to give. Driving higher economic growth is the goal of this tax reform.
This new proposal strikes a fair balance by allowing a reasonable amount of itemized deductions for low- and middle-income taxpayers. The money saved by capping these deductions is then used to lower the income tax rate for everyone.
This tax proposal takes a solid first step toward broadening Georgia’s tax base and significantly reducing the personal income-tax rate. While it’s disappointing that many of the bolder ideas never emerged from the cutting-room floor, state tax systems, like battleships, do not change course quickly or easily. This pro-growth reform will be a boon to small businesses and entrepreneurs, foster job creation and put us in a position to take another major tax-reform step in the near future.
McCutchen is president of the Georgia Public Policy Foundation, an independent think tank that proposes practical, market-oriented approaches to public policy to improve the lives of Georgians.