A Response from Josh

Three quick responses to Nolan’s piece:

1) If we were really serious about adjusting income tax rates for cost of living expenses, then the best way to do this would be to index the marginal tax rates to cost of living by region. Politically, though, this is bound to be a non-starter. But rectifying it through deductions is at best a messy indirect way of addressing the problem: one additional big global form of consumption that Nolan fails to identify is savings for retirement.

2) Reducing the rate at which high income earners can write off tax deductions, in my opinion, is there simply as a way to get an extra tax increase on high income earners into the budget without having to vote directly on a higher marginal tax rate, as he gets his current tax increase just by letting the Bush tax cuts expire. With Nolan’s previous post in mind, though, I’d think supply-siders would actually prefer this kind of tax increase (to, for example, simply raising the highest marginal tax rate to 41% instead of 39.6%), as it doesn’t reduce the incentive to work. What it does do is reduce the incentive to participate in activities the bring about tax write offs. The most popular topic to talk about in this regard in charitable giving, although I think this is kind of red herring. I’ve seen reports of studies saying that people reports tax considerations as very low on their priority list when considering charitable giving, but of course this could be subject to all sorts of response bias. Would be very interested to see if anyone had data/studies on whether changing the marginal tax rates has an effect on charitable giving by the highest wage earners?

3) What is potentially more interesting, however, is that it could begin to address one of the more distortive elements of the US tax code, which is the massive subsidy given to home buyers as opposed to renters. The justification for this subsidy has been that it helps promote an “ownership society” by making it easier for people to move from being renters to home owners, but of course the recent criticism has been that it helped inflate the housing bubble. Seen this in light, the Obama plan is potentially very clever: it keeps the subsidy for low wage earners, but for higher wage earners it might make them think twice about taking on a larger mortgage. So ostensibly it shouldn’t have much of an effect on most potential home owners entering the market, but might control some of the excess at the upper end of the market in the future.