United States: Selected Issues
Author: International Monetary Fund
Publication Date:
02 Aug 2012
eISBN:
9781475504910
Language:
English
Keywords:
ISCR; CR; recession; mortgage; income tax; mortgage interest deduction; OECD country; double taxation; tax code; Income and capital gains taxes; Income; Insurance; Capital gains tax; Tax allowances
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This Selected Issues paper for the United States discusses the microeconomics of the country—household wealth and savings. Households’ consumption-saving decisions have an important bearing on the U.S. economic outlook. This paper demonstrates how households with consistently lower income, which have shown growth in the years prior to the crisis, experienced larger declines in their saving rates and a larger rise in their indebtedness before the crisis, contributing significantly to the dynamics of the mean saving rate.

Abstract

This Selected Issues paper for the United States discusses the microeconomics of the country—household wealth and savings. Households’ consumption-saving decisions have an important bearing on the U.S. economic outlook. This paper demonstrates how households with consistently lower income, which have shown growth in the years prior to the crisis, experienced larger declines in their saving rates and a larger rise in their indebtedness before the crisis, contributing significantly to the dynamics of the mean saving rate.

V. Raising Revenues from U.S. Personal Income Tax Expenditures—OECD Perspective1

A. Introduction

1. The United States needs to raise substantial revenue to reduce its debt and pay the costs of an aging society. One efficient way to contribute to this would be to curtail various significant tax expenditures in the personal income tax (PIT). The PIT expenditures targeted for revenue-raising in this report were selected based on the following criteria: their reduction would raise substantial revenue;2 improve economic efficiency; and increase the progressivity of the income tax. Many tax expenditures under the U.S. PIT, including mortgage interest, charitable contributions, and state and local taxes, take the form of itemized deductions, the incidence of which is generally regressive.3

2. The primary purpose of this note is to compare the U.S. treatment of these items with that commonly used in other industrial countries. Where relevant history exists, the note describes the process of elimination of similar expenditure items in other countries.

B. Housing

Mortgage Interest Deduction

3. Many OECD countries deny a deduction for mortgage interest, including the UK, Canada and Australia. These countries have similar rates of homeownership to the U.S. In contrast, the mortgage interest deduction constitutes the largest PIT tax expenditure in the U.S., other than that for health insurance. Some OECD countries give only limited mortgage interest deductions or use tax credits instead (for example, Denmark; France). A small group of countries (including the Czech Republic, Italy, and Austria) give a virtually unlimited deduction for mortgage interest (OECD, 2011).

4. Neutral taxation of owner-occupied housing would call for taxing its imputed rental value, but allowing a full mortgage interest deduction. Taxing imputed rents has generally proved impracticable, however, although several countries have at one time or another done so. Belgium taxes imputed rent, but the value was last reviewed in 1975 and has been indexed to inflation since 1990, resulting in imputed rents generally below their market counterparts, especially for old houses. In the Netherlands, imputed income is calculated as a percentage (up to 0.55 percent) of a property’s market value. Norway abolished its tax on imputed rents, based on property values, in 2005, and Sweden followed in 2007. While property values provide a readily observable basis for taxing imputed rents, they are likely to represent an imprecise measure of the returns to housing. An alternative is to use house prices and average price-to-rent ratios to estimate imputed rents, but this requires regular updating.4 As imputed rent taxation is thus generally unattractive on administrative grounds, tax neutrality could be better approximated by phasing out mortgage interest deductibility.

5. The U.S. excludes imputed rent and also allows generous mortgage interest deductibility, at a high cost in foregone tax revenues. The U. S. tax code allows the deduction of mortgage interest from taxable income for both first and second homes on mortgages up to $1 million; interest payments on home equity loans of up to $100,000 can also be deducted.5 The U. S. tax treatment provides amongst the most generous tax subsidy for owner-occupied housing of any OECD country (Figure 1).

Figure 1.
Figure 1.

Effective Average Tax Rates on Owner-Occupation

(Personal Income Tax)

Citation: IMF Staff Country Reports 2012, 214; 10.5089/9781475504910.002.A005

Assumptions: Mortgage fixed rate = 6%; Discount rate = 5%; House value = EUR 500,000; House inflation = 5%; Imputed rent =4%; 80% debt financing; Maximum PIT rate.Source: Hemmelgarn, Nicodeme and Zangari (2011).

6. Tax breaks for housing create economy-wide distortions in the allocation of investment across sectors. The marginal effective tax rate on housing investment in the U.S. is currently only 3½ percent, as compared to 25½ percent for business investment in equipment, structures, land and inventories (PERAB, 2010). This discourages investment in productive assets, to the detriment of long-run economic growth. It has also been argued that favorable tax treatment contributed to the housing bubble, although is the data shows only a weak correlation between changes in tax treatment and house prices over time and across states.6

7. Although there is some weak evidence to support positive externalities from home ownership, the mortgage interest deduction is a poor tool to support this objective. The tax treatment of housing changes behavior on two margins—the decision to own or rent and the decision of how much housing to consume – and some work suggests that mortgage interest deductibility influences the latter more than the former.7 Better targeted policy instruments—for example, financial support to reduce down payments for poorer households—would provide a more cost-effective means of encouraging ownership.

8. Abolishing mortgage interest relief would also improve the progressivity of the income tax code. The Urban-Brookings Tax Policy Center estimate that abolishing the mortgage interest deduction would lower after-tax income by 1 percent on average, by less than 0.1 percent for the bottom two income quintiles, and by 1.3 percent for the highest income quintile.8 Higher-income taxpayers stand to lose relatively more due to their higher rate of home ownership, higher likelihood of claiming itemized deductions and higher marginal tax rates. Taxpayers in the top 1 percent of the income distribution would see a below-average decline in their post-tax income, as housing consumption rises less than proportionately with income at very high income levels. Older people tend to have smaller mortgages than younger people, suggesting that the impact of abolition would be distributed unevenly across age groups (Poterba and Sinai, 2008). However, to the extent that the mortgage interest deduction is capitalized in house prices, even homeowners with no mortgage would suffer a one-time drop in the value of their home. Beyond these temporary impacts, abolishing the interest deduction would favor equity over debt finance to purchase homes, to the detriment of younger people who tend to have higher loan-value ratios.9

9. The UK experience offers a lesson in how the mortgage interest deduction can be gradually phased out. Until 1974, mortgage interest tax relief (MITR) in the UK was available for home loans of any size. In that year a ceiling of £25,000 was imposed. In 1983, this ceiling was increased to £30,000, below the rate of both general and house price inflation. From 1983 onwards, the ceiling remained constant, steadily reducing its real value. Beginning in 1991, this erosion of the real value of MITR was accelerated by restricting the tax rate at which relief could be claimed, to the basic 25 percent rate of tax in 1991, and then to 20 percent in 1994, 15 percent in 1995 and 10 percent in 1998. These ceilings on the size of loans and restrictions on the tax rate at which relief could be claimed chipped away at the value of the tax deduction, paving the way for its complete abolition in 2000 (IFS, 2006).

Capital Gains

10. Some capital gains tax (CGT) exemption for primary residences is quite standard in OECD countries, but many countries restrict the exemption by some means.10 Many countries—like the US—impose caps or restrictions on the availability of the CGT exemption. Some countries (Australia, Netherlands, Germany) deny a CGT exemption if the home is also used for business purposes, while others (Austria, Finland, Germany, Iceland, Norway) specify a minimum period of occupation to qualify for the CGT exemption, presumably to discourage speculative activity. Denmark limits the physical size of properties that qualify for the exemption. Others provide tax deferral relief—as in the old US system—through rollover treatment, whereby capital gains taxation may be deferred if the proceeds are reinvested in housing (Spain, Sweden, as well as Iceland under certain conditions). Japan is the only OECD country to fully tax capital gains on primary residences applying rates that vary according to the value of gains and the duration of ownership.

11. Preferential capital gains tax treatment of housing distorts the asset allocation of investment. Owner-occupied housing is purchased in part as a consumption good, but for many households their primary residence represents a vehicle for savings and investment. The favorable capital gains tax treatment of housing therefore creates a bias against investment in more productive financial and business assets. The US exemption is estimated to cost $171 billion in foregone revenues between 2013 and 2017.11

12. The U.S. should consider reducing the tax subsidies for owner-occupied housing provided by capital gains exemption, as well as the mortgage interest deduction. A phased reduction in the CGT exempt amount for primary residences would improve the progressivity and neutrality of the tax system. At the same time, the size of the cap on mortgages that are eligible for tax deductibility of interest could be gradually reduced, alongside restrictions on the tax rate at which mortgage interest can be deducted, eventually resulting in the removal of all the existing tax subsidies for housing. The timing of these reforms requires careful consideration, however. The current tax subsidies are likely to be capitalized in housing prices, suggesting that reforms should be implemented gradually to minimize disruptions to the housing market.

C. State and Local Government

13. The federal government effectively subsidizes state and local governments through open-ended tax preferences—quite a unique policy among developed countries. The U.S. offers several federal tax subsidies to state and local governments (SLGs) that lower the cost of raising sub-national revenues and carrying out investments, the largest of which are the deductibility of state and local taxes under the federal income tax and the exemption from federal income tax of the interest on municipal bonds. Typically, OECD governments support SLGs through direct grants and revenue sharing.12 One benefit of direct spending as opposed to tax subsidies is that it is more transparent, since it must pass through the appropriations process.

Deduction of State and Local (S&L) Taxes

14. Taxpayers who itemize their deductions may deduct from their federal income taxes S&L residential and personal property taxes, as well as either S&L income tax or sales taxes.13 OMB estimates the current revenue loss from S&L property tax deductions at $141 billion and from other S&L non-business taxes at $295 billion. Because wealthier individuals are more likely to itemize, have larger S&L tax bills, and face higher marginal federal tax rates, the deductibility of S&L taxes is highly regressive (Table 2).

Table 1.

Value of U.S. PIT Tax Expenditures

article image
Source: OMB (2012)
Table 2.

Effect of Eliminating Deductibility of All S&L Taxes

article image
Source: Metcalf (2011)

15. If local taxes are essentially a benefit tax, then they represent a charge for consumption of local public services and should not be deductible in the non-business context from federal income tax liability. Property taxes in particular are usually viewed as payments for local services such as schools, infrastructure and public safety, so their deductibility is theoretically inappropriate. Sales taxes are a form of consumption tax, which should also not be deductible for income tax purposes. The argument for deductibility in order to avoid double taxation of income is not particularly well founded. Regardless, however, as states use income and sales tax revenues to pay for the same public goods, a deduction for income taxes only would distort state financing choices.14

Public Purpose S&L Bonds

16. The exclusion of interest on “municipal” or S&L government public purpose bonds and qualified private activity bonds is an inefficient subsidy. Interest on municipal bonds is not included in bondholders’ federal income tax base; however, interest on private activity bonds—those issued by S&L governments on behalf of private interests—is taxable under the individual alternative minimum tax (AMT). Because of the income tax exclusion, investors are willing to accept a below-market return on them: An investor with a marginal PIT rate of t is willing to accept a tax-free yield of (1-t)*r, where r is the interest rate on taxable bonds. S&L governments are therefore able to borrow at below-market rates.

17. Because the market-clearing investor in municipal bonds usually faces a PIT rate below the top rate, investors in the top bracket(s) receive more interest than they need to induce them to buy the bonds. The revenue cost to the federal government of providing the interest rate subsidy exceeds the benefit to S&L local governments, with the difference captured by high-bracket investors. OMB (2012) estimates that the exclusion of interest on public purpose bonds costs $228 billion over 5 years, while the exclusion for private activity bonds costs another $67 billion. Because the benefit of holding tax-exempt bonds vs. taxable bonds is increasing in an investor’s marginal tax rate, the majority of tax-exempt bonds are held by investors in the top bracket.15

18. There are at least two options for reforming the inefficient subsidy for municipal debt. One option is for the federal government to replace the interest exclusion on new municipal bonds with tax credits, as under the Qualified Zone Academy Bond program. The interest on tax credit bonds is taxable, but investors receive a tax credit for a certain percentage of the interest, giving each investor just sufficient subsidy to hold the bond, so the inefficiency of the interest exclusion is eliminated.16 A second option is for interest to be fully taxed and the federal government to pay out a certain percentage of the face value of debt issued for qualifying purposes as grants, as under the Build America Bond program. CBO (2011b) estimates that replacing the S&L interest exclusion for new bond issues with a grant equal to 15 percent of their face value would save the federal government $143 billion over the next decade.

D. Health Insurance

19. The tax treatment of healthcare insurance varies across OECD countries, reflecting in part different models for the financing and provision of healthcare services. Canada and Ireland provide generous tax incentives for insurance costs and do not levy income tax on health insurance contributions paid by employers. France allows employees to deduct insurance premiums paid by their employers from their taxable income, while Germany provides tax deductions for premiums and out-of-pocket expenses up to a limit. At the less generous end of the spectrum, Australia imposes a fringe benefit tax on employer-provided insurance, and the UK abolished tax deductions for private health costs in 1997.17 However, even in countries with generous tax subsidies for private insurance, the fiscal cost tends to be lower as a percent of GDP than in the U.S., due to the larger role of public financing in health care provision. Estimates published by national governments show health-related tax expenditures cost 1.05 percent of GDP in the U.S. in 2008, compared to 0.27 percent in Canada, 0.29 percent in Korea, and zero in Germany, Spain, the Netherlands and the UK. 18

20. The U.S. income tax code provides for the exclusion or deduction of health insurance premiums or expenses, and exempts medical benefits, at a high revenue cost. Employer-provided health insurance premiums, as well as employee contributions in some cases, are excluded from taxable income. The tax code also allows for medical expenditures beyond a certain share of adjusted gross income to be deducted from taxable income as itemized deductions and taxpayers with high-deductible health insurance policies can contribute to health savings accounts from pretax dollars. Finally, medical benefits provided by employers to their employees are not subject to income or payroll tax. These exclusions, deductions and exemptions for individuals are estimated to cost in excess of $1 trillion in foregone tax revenues between 2013 and 2017.19

21. The generous tax treatment of medical care expenses is estimated to be generally regressive. This reflects in part low insurance coverage rates among those in the lowest income quintile. At the top of the income distribution, insurance coverage rates are very high and the average insurance benefit increases only slightly in line with income. As a result, the regressive impact stops well below the top 0.1 percent of the income distribution, with the latter gaining much less as a share of their after-tax income from tax subsidies for healthcare than those in the 80th to 90th percentiles.20 Beginning in 2014, individuals with household income between 100 and 400 percent of the poverty line will be eligible for a premium tax credit when purchasing health insurance through insurance exchanges. This credit has the potential to improve the progressivity of the tax treatment of health insurance.

22. Tax subsidies for employer-sponsored health insurance encourage risk pooling among employees, but also provide an incentive for excessive consumption of healthcare services. Out-of-pocket expenses will typically be less than the true cost of healthcare provision—with the difference paid by the insurer—the result is likely to be over-consumption of healthcare. The tax subsidy may be an important contributor to this moral hazard, which contributes to high levels of excess growth in healthcare costs in the U.S. relative to other advanced countries.21

23. Capping the tax exclusion for employer-sponsored health insurance would deliver significant fiscal revenues and contribute to health care cost control. The high fiscal cost of tax subsidies for health insurance could be reduced by capping the dollar amount of the tax exclusion for employer-sponsored insurance, either on a per person or per tax return basis.22 Such a cap would also reduce the incentive to over-consume health insurance, and if indexed to the consumer price index (which typically grows more slowly than medical costs) would lead to a declining tax subsidy over time. Alternatively, the current exclusion for employer-sponsored insurance could be replaced with a limited tax deduction.

E. Charitable Contributions

24. Most OECD countries provide tax incentives for charitable giving, although sometimes in the form of a tax credit or with a cap. The UK, Australia and Germany provide tax deductions for donations, the value of which depends on a taxpayer’s marginal tax rate, while Canada, New Zealand and France provide tax credits (Table 3).23 Denmark, New Zealand, Norway and, recently, the UK cap the amount of deductions or credits that can be claimed.

Table 3.

Tax Incentives for Charitable Giving in Selected OECD Countries

article image
Source: IBFD and OECD (2010), “Taxing Wages”. Marginal income tax rate for single individual earning 167 percent of the average wage in 2010.

25. The U.S. income tax code includes an itemized deduction for charitable donations, subject to a ceiling, that looks generous by OECD standards. Charitable contributions to qualified non-profit organizations are deductible from taxable income for taxpayers who itemize. The itemized deduction for cash donations is capped at 50 percent of a taxpayer’s adjusted gross income,24 and is estimated to cost $294 billion over the period 2013 to 2017.25 In addition, bequest donations can be deducted from the total value of the estate before estate tax liability is calculated.

26. The public good nature of charitable giving provides a rationale for governments to subsidize donations, but it is important to ensure that the level of tax subsidy is cost effective. Tax deductibility reduces the after-tax price of giving, providing a subsidy to charitable donations, and various estimates in the literature suggest that charitable giving responds positively to this price incentive.26 However, these tax subsidies reduce the amount of funds available to government to make direct transfers to charitable causes. If, as the recent U.S. literature suggests, the price elasticity of charitable giving is less than one in absolute value, then the government could remove the tax incentive, make up the lost private donations from public funds and still realize a net budgetary saving.27

27. Setting a floor below which charitable donations would not be eligible for preferential tax treatment would reduce the revenue cost, with little impact on the size of donations. A fixed dollar floor would allow taxpayers to claim an itemized deduction only for charitable donations in excess of a threshold—for example, CBO (2011) has analyzed a floor of $500 for individuals and $1,000 for joint filers. Most donations come from taxpayers who give more than this floor, and for these taxpayers the marginal tax incentive to give an extra $1 to charity would be unchanged. The CBO estimate that this reform could reduce the cost of the tax subsidy by around 14 percent, while reducing charitable donations by less than 1 percent (as the marginal tax incentive is eliminated only for small donations). This option appears reasonably progressive—tax subsidies for charitable donations would fall by 0.03 percent of adjusted gross income for individuals with income below $50,000, compared to a reduction of 0.12 percent for those earning between $100,000 and $200,000. Converting the deduction into a non-refundable tax credit, equal to a percentage of donations, would further reduce the revenue cost, and would eliminate the regressivity in the current tax treatment.

F. Taxation of Capital Income

Capital Gains

28. A reduced tax rate on corporate capital gains and corporate dividends can be justified to alleviate corporate double taxation and the debt bias, but reduced tax rates on other forms of capital gains are not. A reduced tax rate on (long-term) capital gains is usually justified on the grounds of alleviating “lock-in”, as well as the tax on inflationary gains. Lock-in arises due to taxation of capital gains only on realization: when an asset is sold. The ideal alternative is accrual, or “mark-to-market” taxation, which would tax (or deduct) the change in value of assets each year. This is generally not done, since it requires regular asset valuation which is difficult in the case of illiquid assets, and could force liquidation of assets to pay the tax. Taxpayers therefore have an incentive to retain appreciated assets to avoid paying the tax. Although a low (or zero) capital gains tax reduces lock-in, it distorts investment decisions by causing investors to favor assets that generate capital gains rather than current income. An example of this is “corporate lock-in”, in which corporations retain earnings rather than distribute them as dividends in order to appreciate their share prices. Other forms of financial arbitrage that convert current income into capital gains are also encouraged by the reduced rate.

29. OECD countries cite the tension between concerns about lock-in and financial arbitrage as critical in determining their choice of capital gains tax rates. Those more concerned about lock-in as well as administrability tend to have low or zero capital gains rates, whereas those preoccupied with preventing arbitrage and base erosion tend to tax capital gains more comprehensively. Countries including the U.K., Canada, and Australia tax most capital gains; others including Germany, the Netherlands, and Mexico impose capital gains taxes only on selected items.

30. The U.S. applies a reduced tax rate on long-term capital gains and qualified dividends that costs $343 billion over 5 years. The U. S. tax code has usually included a lower rate for “long-term” capital gains (currently defined as gains on assets held for at least one year). Unless the 2003 changes are extended, the rate on long-term capital gains will revert to 20 and 10 percent in 2013, and dividends will again be taxed as ordinary income.

31. A reduced tax rate on corporate capital gains and dividends alleviates the “double taxation of corporate income.” Given that corporate income is taxed at the 35 percent CIT rate (currently equivalent to the top PIT rate), taxing it again when distributed as dividends or capital gains imposes a heavier burden on corporate equity than other forms of investment—and a much heavier burden than that on corporate debt, since interest is deductible. A strong case can be made for policies that reduce this corporate “debt bias”, such as corporate integration or an allowance for corporate equity (ACE).28

32. Most OECD countries therefore offer some sort of reduced tax rate on capital gains on corporate shares, which is often restricted by holding period or ownership share.29 Like the U.S., the U.K. offers a progressive schedule of reduced rates, while France and Japan offer a reduced flat rate. Australia and Canada tax only 50 percent of gains at ordinary PIT rates.30 Germany exempts gains on shares held more than one year, while the Netherlands, New Zealand, Switzerland and Mexico exempts all gains on quoted shares.31

33. Non-corporate capital gains, however, do not represent income that has already been taxed. “Carried interest” treatment taxes as capital gains some income earned by principals of pass-through entities that is arguably labor income and should therefore be subject to ordinary income tax rates.32 Profits from livestock sales, which are mostly earned by agricultural businesses and should be ordinary income, are subject to reduced capital gains tax rates. Capital gains on primary residences are also often untaxed (see previous section). These sorts of capital gains should be taxed at ordinary PIT rates. As roughly one quarter of capital gains are on corporate shares (and stock mutual funds),33 eliminating the reduced capital gains tax rate on other items would raise approximately $216 billion over five years.

34. The U.S. tax-free step-up in basis at death for appreciated assets is often criticized for exacerbating the lock-in effect. Proponents of the policy justify it on the grounds that the estate tax has usually been levied at a much higher rate than the tax on longterm capital gains or even the top PIT rate. However, income and estate/inheritance taxes have different aims. OMB (2012) estimates that the step up in basis at death costs the federal government $182 billion over 5 years. OECD countries vary in their treatment of capital gains at death and their interaction with estate or inheritance taxes.34 Several countries, including the U.K. and Mexico, give a step-up in basis at death. Alternatives to this regime include taxing accrued capital gains upon death - Canada, New Zealand and Denmark do this, with a subsequent step- up in basis; or carrying over the decedent’s basis to his or her heirs, as occurs in Australia, Sweden and Spain.35 Of these countries, the U.K., Spain and Denmark also levy an inheritance tax, but Mexico, Australia, New Zealand, Canada, and Sweden do not.

G. Retirement Savings Accounts

35. The U.S. tax code provides for reduced taxation of several different long-term savings vehicles. The largest of these income tax expenditures are: 401(k)-type plans, employer-provided retirement plans, self-employed plans, and individual retirement accounts (IRAs). With the exception of Roth IRAs, which account for roughly one quarter of the total IRA tax expenditure of $100 billion, contributions to these vehicles are out of pre-tax income (i.e., they are deductible); their investment earnings are untaxed; and withdrawals are fully taxed: so-called “EET” treatment.36 For Roth IRAs, contributions are made out of taxable income, but earnings accumulate tax-free and withdrawals are also untaxed. Both of these regimes are equivalent to consumption tax treatment of investment. Under income tax treatment—the treatment applied to most other forms of saving—contributions are made out of after-tax income, earnings are taxed, and distributions are not taxed (“TTE”).37

36. Contributions to retirement savings vehicles are generally capped in each tax year. Despite the contribution limits, however, the tax benefits of retirement savings provisions flow largely to wealthier individuals (Table 4).

Table 4.

Effect of Eliminating PIT Tax Expenditures for Retirement Savings

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Source: Toder et al. (2012)

37. Like the U.S., the great majority of OECD countries offer tax-advantaged treatment for pension savings, mostly through EET regimes.38 The most common rationales for this policy are to provide an incentive for private retirement savings and compensate investors for restricted access to savings before retirement. Also like the U.S., many of the countries with EET regimes, such as France, Germany and Japan, tax distributions only partially. Nonetheless, a few countries do not privilege retirement savings under the income tax: Denmark, Italy and Sweden have ETT regimes, and New Zealand has a TTE regime (Yoo and De Serres, 2004).

38. Although the U.S. regime is in accord with most international practice, the U.S. has an above-average cost of foregone revenue from its retirement savings regime: around $0.27 per dollar of savings.39 To reduce this cost, the cap on contributions out of pretax income to all pension schemes could be unified and lowered to reduce tax benefits for upper-income taxpayers, whose saving decision would likely be little changed as a result. The CBO estimates that unifying and reducing the retirement plan contribution limit to $14,850 and the IRA contribution limit to $4,500 for all taxpayers would save $16 billion over the next 5 years and an additional $30 billion through 2021. A second option the CBO considers is bringing untaxed Social Security and railroad retirement benefits into the tax net, which would clearly be more regressive than lowering the contributions cap.

H. Conclusions

39. The favorable tax treatment of housing is costly in terms of foregone revenues and economic distortions and should be a high priority for gradual reform as the housing market regains strength. The mortgage interest deduction and the capital gains exempt amount for first homes are estimated to cost $778 billion in foregone revenues between 2013 and 2017, making them among the most costly tax expenditures under the PIT. In addition to the high budgetary costs, these tax subsidies for housing distort savings and investment decisions and are highly regressive, while being poorly targeted at increasing home ownership rates.

40. Reforms to the tax treatment of state and local government and of employer-sponsored health insurance should also be given high priority. The open-ended federal tax subsidies to state and local governments are estimated to cost $731 billion in foregone revenues between 2013 and 2017 and are uniquely generous by OECD standards. The tax exclusion of employer-sponsored health insurance premiums is estimated to cost $1,012 billion over the same period, and contributes to high rates of health care cost inflation. In both cases, replacing the current tax deductions with better-targeted tax credits would realize sizeable budgetary savings and reduce the regressivity of the current tax treatment.

41. Favorable capital gains tax treatment of gains at death and of long-term gains is moderately expensive, and should be considered a medium priority for reform. The step-up in basis at death favors assets yielding capital gains over current income and exacerbates lock-in. The reduced tax rate on long-term capital gains can be justified for gains on corporate shares to alleviate double taxation. However, the U. S. should remove the favorable treatment of non-corporate gains where double taxation is not a valid concern. In total, these two tax expenditures cost an estimated $398 billion in foregone revenues over five years (excluding the reduced CGT rate on corporate gains).

42. Tightening the limits on tax deductibility of contributions to charities and retirement savings vehicles represent lower priority reforms. The principle of providing favorable tax treatment for such contributions can be justified as correcting market failures, and is consistent with the tax treatment in other OECD countries. However, there is scope to curtail the budgetary cost of these tax expenditures to yield modest savings while retaining the tax incentive for contributions and improving their progressivity.

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1

Prepared by Jack Grigg and Thornton Matheson (Fiscal Affairs Department).

2

The 5-year revenue cost of the tax expenditures considered in this paper (Table 1), estimated by OMB (2012), assume no behavioral changes. Further, because each tax expenditure is estimated in isolation holding all other features of the code constant, they cannot in general be aggregated.

3

U.S. taxpayers have the option of either itemizing their income tax deductions or taking the standard deduction, which in 2012 varies between $5,950 and $11,900 for non-dependents. The standard deduction is set to correspond roughly to the average value of itemized deductions for moderate-income taxpayers. Taxpayer s with deductible expenses in excess of this amount, who tend to be higher-income individuals, have an incentive to itemize.

5

The exclusion of imputed rent, net of mortgage interest and other housing-related costs is estimated to cost $337 billion in foregone revenues over five years. The mortgage interest deduction reduces income tax revenues by $606 billion. The tax expenditure from tax-favored treatment of housing equals the sum of these two revenue losses, as imputed rents are measured net of mortgage interest costs.

6

The substantial increase in the capital gains tax exemption for housing in 1997 is sometimes cited as an inflection point for house prices. However, this was accompanied by elimination of rollover relief, whereby gains on disposal of a house were previously untaxed if the proceeds were reinvested in another property.

7

Glaeser and Shapiro (2002). There are negative aspects of ownership as well, notably that transactions costs limit mobility in response to labor market shocks.

8

Urban-Brookings Tax Policy Center (2009).

9

For a discussion of how the mortgage interest deduction equalizes the tax treatment of debt and equity finance to purchases homes, see Woodward and Weicher (1989).

10

OECD (2006), based on tax treatment as of July 2004.

11

OMB (2012). The US exemption is limited to $250,000 ($500,000 for joint filers), with some additional restrictions. The revenue cost may be higher during periods of more robust growth in housing prices.

12

The U.S. federal government supports S&L governments with matching and block grants, but revenue sharing was eliminated in 1986.

13

The deductibility of S&L sales taxes was eliminated in 1986, but reintroduced in 2004 as an alternative to deduction of S&L income tax, a provision sought by the nine U.S. states—Alaska, Florida, Nevada, New Hampshire, South Dakota, Texas, Tennessee, Washington and Wyoming—that do not levy income taxes.

14

Metcalf (2011) shows that deductibility does influence state choice of tax instruments, and that deductibility leads to higher levels of state spending. Therefore, the progressivity of eliminating the deduction for SLG taxes would be offset to some degree by the resulting reduction in progressive SLG spending programs.

18

OECD (2010). Estimates relate to the year 2006 for Germany, Korea, the Netherlands and the UK, 2004 for Canada and 2008 for Spain.

20

Urban-Brookings Tax Policy Center (2009).

21

IMF (2010), “Macro-Fiscal Implications of Health Care Reform in Advanced and Emerging Economies”

22

JCT (2008), “Expenditures for Health Care”.

23

Many countries, including the US, also provide preferential tax treatment for corporate donations to charities.

24

The cap is set at 30 percent of adjusted gross income for donations for donated property that has appreciated in value since it was initially acquired.

26

The elasticity in the US is estimated to be around 0.5 (Andreoni 2001).

27

This ignores the role of charitable giving in eliciting the preferences of donors.

28

Corporate integration is alleviating the double taxation of corporate equity, either through imputation, in which shareholders receive a credit for taxes paid at the corporate level, or through a low or zero rate on dividends. An ACE would allow corporations a deduction for the cost of equity finance.

29

“Controlling shares,” defined in terms of the percentage of total equity held, are generally taxed at higher rates than portfolio shares.

30

In Australia the exclusion is restricted to shares held for at least one year.

31

Some dividends and capital gains arise from income that, due to corporate tax incentives, was never taxed at the corporate level. This can be addressed through integrating corporate and investor levels of tax. Australia, Canada, Mexico and New Zealand have imputation schemes. The E.U. has moved from imputation toward partial dividend exclusion, to equalize tax treatment of cross-border and domestic shareholdings.

32

OMB (2012) estimates the cost of the carried interest policy at $8.2 billion over 5 years.

34

An inheritance tax applies to the amount received by each heir rather than the estate as a whole, and thus if it is progressive encourages wider distribution of an estate’s assets.

36

EET = exempt, exempt, taxed.

37

Some social security income is also untaxed upon distribution, costing $150 billion over 5 years.

38

Hungary, by contrast, has a TEE regime.

39

Yoo and De Serres (2004) characterize the U.S. contribution limits as relatively generous compared with those of other developed countries.

Same Series

Other IMF Content

Other Publishers

Cover IMF Staff Country Reports
United States: Selected Issues
Author: International Monetary Fund
Volume/Issue:
Volume 2012: Issue 214
Publisher:
International Monetary Fund
ISBN:
9781475504910
ISSN:
1934-7685
Pages:
119
DOI:
https://doi.org/10.5089/9781475504910.002
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    Effective Average Tax Rates on Owner-Occupation

    (Personal Income Tax)

Effective Average Tax Rates on Owner-Occupation

(Personal Income Tax)