Killing Them Softly
Trump plan retains deductions for mortgages and charitable gifts, but eliminates the incentive for most taxpayers
[This post is co-authored with Kyle Rozema, the inaugural Wachtell Lipton fellow in behavioral law and economics at the University of Chicago Law School.]
The tax blueprint released by the Trump administration in conjunction with congressional Republican leaders on Wednesday says that it “retains tax incentives for home mortgage interest and charitable contributions.” And it is true that, as a formal matter, the deductions for home mortgage interest and charitable contributions would remain on the books under the new plan. However, the vast majority of taxpayers who claim those deductions today would not continue to do so under the Trump plan, and so would lose the tax incentive for mortgage interest payments and charitable contributions. We estimate that only 3% of single taxpayers — and 6% of married couples filing jointly — would receive a tax benefit for home mortgage interest payments under the Trump plan, and a similar proportion of taxpayers would receive a tax benefit for charitable contributions.
At least three factors in the Trump plan would remove or dampen these tax incentives for most taxpayers. First, the plan would raise the standard deduction significantly — from $6,350 to $12,000 for single taxpayers and from $12,700 to $24,000 for married taxpayers filing jointly. A larger standard deduction would lead many taxpayers who currently itemize and thus benefit from the mortgage interest and charitable contributions deduction to claim the standard deduction. In particular, the proposed change means that single taxpayers with less than $12,000 in home mortgage interest payments and charitable contributions (or married taxpayers with less than double that amount) will choose the standard deduction instead of itemizing under the Trump plan because doing so leads to a lower tax bill.
Second, the Trump plan would scrap all itemized deductions other than for home mortgage interest and charitable contributions. Most significantly, the plan would eliminate the existing itemized deduction for state and local taxes. To see how this change will affect the number of taxpayers claiming the mortgage interest and charitable contribution deductions, consider the example of a married couple with $10,000 in deductible state and local tax payments, $10,000 in mortgage interest payments, and $10,000 in charitable contributions. Under current law, the couple chooses to itemize deductions because the couple’s $30,000 in itemized deductions is greater than the $12,700 standard deduction. Under the Trump plan, by contrast, the couple would claim the standard deduction because the couple’s $20,000 in itemized deductions would be less than the new $24,000 standard deduction.
Third, insofar as the plan reduces marginal rates, it likewise weakens the tax incentive for home mortgage interest payments and charitable contributions. A deduction of a given amount is worth less to a taxpayer facing a 39.6% marginal rate (the top statutory rate under current law) than to a taxpayer facing a 35% marginal rate (the top rate under the Trump plan). Because we do not know where the new 12%, 25%, and 35% brackets will begin and end, we cannot yet say how many taxpayers will face a lower marginal rate under the Trump plan than they do today. But if the Trump plan delivers on its rate reduction promises, then the value of itemized deductions will decline commensurately.
To estimate how many taxpayers would no longer claim the mortgage interest and charitable contribution deductions under the Trump plan, we examined the most recent data available to us from the Internal Revenue Service’s Statistics of Income file (for filing year 2012). We first determined whether each taxpayer claimed the mortgage interest and charitable contribution deductions. We then considered whether taxpayers claiming either of the deductions would have paid less in taxes by taking a standard deduction instead of itemizing under the Trump plan. We conducted separate analyses for single taxpayers and married taxpayers filing jointly. We excluded taxpayers claiming head-of-household and married-filing-separately status because the Trump plan does not reveal how those taxpayers would be treated.
Tables 1 and 2 summarize our results. Table 1 shows the percentage of taxpayers claiming the mortgage interest and charitable contribution deductions under current law and under the Trump plan. The proportion of single taxpayers claiming the mortgage interest deduction decreases from 13% to 3%, and the proportion of joint filers benefitting from the mortgage break falls from 42% to 6%. Our results for the charitable contribution deduction are similar: the proportion of single taxpayers claiming the charitable contribution deduction decreases from 14% to 3%, and the proportion of joint filers claiming the deduction declines from 41% to 6%.
Table 2 shows the percentage change in total dollars deducted for mortgage interest and charitable contributions under current law and the Trump plan. Note that this is not the same as the percentage change in total benefits resulting from these provisions; to calculate the latter figures, we would have to know the width of the new tax brackets. Even so, Table 2 provides a first cut at the effect of the Trump plan on the overall tax incentive for mortgage interest payments and charitable contributions. We find that deductions claimed for mortgage interest payments decrease by more than half for single and joint filers, while deductions claimed for charitable contributions fall by just under half.
Our analysis has two important implications. First, it illustrates the tension between the Trump plan’s proposal to expand the standard deduction and the plan’s discussion of tax incentives for mortgage interest payments and charitable contributions. The plan states that “tax incentives for home mortgage interest and charitable contributions . . . help accomplish important goals that strengthen civil society, as opposed to dependence on government: homeownership and charitable giving.” Yet the plan would significantly weaken the current system’s incentives for homeownership and charitable giving, because most taxpayers that currently benefit from these provisions would no longer face a tax incentive at the margin for mortgage interest payments and charitable contributions.
Second, our analysis highlights the political challenges that the Trump administration and congressional Republicans will face in passing their proposal. While the American Bankers Association and the National Association of Home Builders have made positive statements about the new tax plan in the past day, the plan has elicited a frostier reception from other groups representing mortgage lenders and real estate industry professionals, who worry that the changes in the plan will discourage both home purchases and taking out mortgages. Meanwhile, nonprofit leaders are already warning that the expansion of the standard deduction — along with the elimination of the estate tax — could cut into charitable giving significantly. Whether or not these predictions turn out to be correct, opposition to the current proposal from powerful interest groups will make it more likely that the new tax plan goes the way of the Better Care Act and Graham-Cassidy.