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The Tax Cuts and Jobs Act dramatically increased the standard deduction while eliminating the personal exemption and making other changes that left tax-free thresholds (the amount of income that households can earn before owing income tax) largely unchanged. The primary effect of those policy changes was to increase the floor on itemized deductions and dramatically reduce the number of taxpayers claiming those deductions.
Although the reduction in the number of itemizers lowered administrative and compliance costs, the cost savings are too modest to justify the increase in the standard deduction. If itemized deductions are otherwise good policy, the administrative and compliance costs associated with claiming them are too small to justify denying deductions to taxpayers with tens of thousands of dollars of qualifying expenditures.
Instead, the TCJA’s increase in the standard deduction appears to have been intended to indirectly curtail itemized deductions that were seen as unjustified but were too popular to directly limit. Unfortunately, increasing the standard deduction is a problematic way to curb tax preferences. That strategy curtails all tax preferences that are provided through itemized deductions, no matter how beneficial they may be, while sparing all tax preferences that are provided through exclusions, preferential rates, above-the line deductions, and credits, no matter how pernicious they may be. Further, the strategy curbs the affected tax preferences for only some taxpayers, generally making the preferences more poorly targeted.
The impact on charitable contributions and owner-occupied housing vividly illustrates the limitations of using a larger standard deduction to curtail tax preferences. The increase in the standard deduction reduces the incentive for charitable giving, despite the absence of any stated rationale for reducing that incentive. The increase in the standard deduction also confines the incentive for charitable giving to a relatively small group of largely affluent taxpayers, moving it even further away from a uniform incentive that promotes giving by all income groups. The increase in the standard deduction also reduces the overall preferences for owner-occupied housing, which is the strongest argument for the change. However, it leaves the preference intact for the most affluent households. Because those households are unlikely to rent in any case, the increase in the standard deduction moves the housing tax preference even further away from any effective role in promoting home-ownership and skews it even more toward encouraging purchases of larger and more expensive houses.
Future tax reforms should directly curtail or eliminate unjustified itemized deductions, along with other unjustified tax preferences. Justified deductions should be available to all taxpayers, except those with expenditures so small that tracking and verifying them imposes excessive administrative costs. Such a tax system would have no role for a standard deduction of the type found in today’s tax system. Increases in the personal exemption and similar provisions would be used to provide an adequate tax-free threshold and protect low-income households.
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