Eliminate Itemized Deductions
CBO periodically issues a compendium of policy options (called Options for Reducing the Deficit) covering a broad range of issues, as well as separate reports that include options for changing federal tax and spending policies in particular areas. This option appears in one of those publications. The options are derived from many sources and reflect a range of possibilities. For each option, CBO presents an estimate of its effects on the budget but makes no recommendations. Inclusion or exclusion of any particular option does not imply an endorsement or rejection by CBO.
|Billions of Dollars||2019||2020||2021||2022||2023||2024||2025||2026||2027||2028||2019-
|Change in Revenues||37.4||71.7||76.5||80.9||84.6||87.7||90.6||201.1||286.5||295.1||351.1||1,312.0|
When preparing their income tax returns, taxpayers may choose either to take the standard deduction—which is a flat dollar amount—or to itemize and deduct certain expenses, such as state and local taxes, mortgage interest, charitable contributions, and some medical expenses. Taxpayers benefit from itemizing when the value of their deductions exceeds the amount of the standard deduction. (For 2018, that amount ranged from $12,000 for a single filer to $24,000 for a married couple filing jointly.) The fact that those expenses are deductible reduces the cost of incurring them, so, in effect, the itemized deductions serve as subsidies for undertaking deductible activities. Most of the tax savings from itemized deductions constitute a "tax expenditure" by the federal government. (Tax expenditures resemble federal spending by providing financial assistance for specific activities, entities, or groups of people.)
The tax code imposes several limits on the amount of itemized deductions taxpayers can claim. For 2018, taxpayers cannot deduct more than $10,000 in state and local taxes, nor can they deduct home mortgage interest on loan amounts in excess of $750,000. For some types of expenses (such as medical expenses), only the amount that exceeds a certain percentage of the taxpayer's adjusted gross income (AGI) can be deducted. (AGI includes income from all sources not specifically excluded by the tax code, minus certain deductions.)
Many tax rules relating to deductions will change in 2026, when most changes to the individual income tax system made by the 2017 tax act expire. The size of the standard deduction will be reduced by roughly 50 percent, making itemization a better choice for many taxpayers. Several restrictions on deductions that were put in place by the act will no longer be in effect. The limit on state and local taxes will be removed, and the limitation on mortgage interest will revert to the higher amount ($1.1 million) set by pre-2018 tax law. Additionally, several itemized deductions (such as the deductions for unreimbursed employee expenses and tax preparation fees) that were temporarily eliminated by the 2017 act will be reinstated. And a provision that reduced the total value of certain itemized deductions by 3 percent of the amount by which a taxpayer's AGI exceeded a specified threshold will come back into effect. The net effect of those changes will be to increase the number of taxpayers who itemize and the amount of deductions they claim.
In 2015, almost 45 million taxpayers itemized their deductions, according to the Internal Revenue Service. Their itemized deductions totaled almost $1.3 trillion; by comparison, if those taxpayers had claimed the standard deduction, their taxable income would have been $800 billion higher. The change in taxes from itemized deductions depends on the taxpayer's marginal tax rate (the percentage of an additional dollar of income that is paid in taxes). For instance, $10,000 in deductions reduces tax liability by $1,500 for someone in the 15 percent tax bracket and by $2,800 for someone in the 28 percent tax bracket. As a result of temporary changes enacted by the 2017 tax act, the Congressional Budget Office projects that the number of itemizers will fall by more than 60 percent from 2017 to 2018 and the value of those itemized deductions will fall by about 35 percent. Absent those legislated changes, the amount of itemized deductions was projected to grow slightly faster than income.
This option would eliminate all itemized deductions. As a result, all taxpayers who would otherwise itemize deductions would have to claim the standard deduction, which generally would be of less value to them. Taxpayers who would have claimed the standard deduction would be unaffected by the change.
Effects on the Budget
If implemented, this option would increase revenues by $1.312 billion from 2019 through 2028, the staff of the Joint Committee on Taxation estimates. That estimate incorporates expected reductions in spending by taxpayers on deductible activities. For example, taxpayers would be likely to decrease their charitable contributions and mortgage indebtedness under this option.
The increase in revenues from this option would rise sharply after most changes to the individual income tax system made by the 2017 tax act expire at the end of 2025, for two reasons. As noted above, the expiration of those changes will substantially increase the number of taxpayers who itemize and the amount of deductions they claim. Consequently, the increase in revenues from eliminating deductions would be much larger in later years. Second, marginal tax rates are generally higher after 2025 than under the 2017 tax act.
The estimated increase in revenues from this option is uncertain because both the underlying projection of itemized deductions and the estimated response to the change in the tax treatment of those deductions are uncertain. Projections of spending on deductible items are inherently uncertain because they are based on CBO's projections of the economy over the next decade. That uncertainty is compounded because the projections reflect the effects of the 2017 tax, which are also quite uncertain. Finally, the estimates rely on expectations of how taxpayers will change their behavior in response to changes in the tax treatment of itemized deductions. Those expectations are based on observed responses to past changes, which might differ from the response to tax changes considered here.
One argument for eliminating itemized deductions is that their availability encourages spending on deductible activities because of the tax benefits those activities provide; that tendency can lead to an inefficient allocation of economic resources. For example, the mortgage interest deduction distorts the housing market by prompting people to take out larger mortgages and buy more expensive houses, which pushes up home prices. People therefore invest less in other assets than they would if all investments were treated equally. And the deduction for state and local taxes encourages state and local governments to raise taxes and provide more services than they otherwise would (although some research indicates that total spending by state and local governments is not sensitive to that incentive). Eliminating itemized deductions would remove such incentives to spend more on certain goods or activities. Reducing taxpayers' engagement in some activities for which expenses can be deducted under current law—in particular, activities that primarily benefit those taxpayers—could improve the allocation of resources. However, reducing engagement in other activities for which expenses can be deducted—in particular, activities that offer widespread benefits—could worsen the allocation of resources. An oft-cited example of tax-deductible spending in the latter category is contributions to charitable organizations.
Another argument for eliminating itemized deductions is that taxpayers with higher income benefit more from those deductions because they have more expenses that can be deducted, which makes them more likely to itemize, and because the per-dollar tax benefit of those deductions depends on a taxpayer's marginal tax rate, which rises with income. CBO estimates that in calendar year 2013 (the most recent year for which estimates are available), more than 80 percent of the tax expenditures resulting from the three largest itemized deductions—for state and local taxes, mortgage interest, and charitable contributions—accrued to households with income in the highest quintile (or one-fifth) of the population (with 30 percent going to households in the top 1 percent of the population). In 2013, the tax benefit of those three deductions equaled 0.1 percent of after-tax income for households in the lowest income quintile, 0.4 percent for the middle quintile, 2.5 percent for the highest quintile, and 3.9 percent for the top percentile. Hence, reducing or eliminating them would increase the progressivity of the tax code—that is, it would increase average tax rates by more for higher-income taxpayers than for lower-income taxpayers.
A third argument for this option is that eliminating itemized deductions would simplify the tax code. Taxpayers would no longer have to keep records of their deductible expenses or enumerate them on the tax form.
An argument against this option is that some deductions are intended to yield a measure of taxable income that more accurately reflects a person's ability to pay taxes. For example, the deductions for payments of interest on money borrowed to purchase taxable investments, known as the investment interest expense deduction, allow people to subtract the costs they incurred to earn the income that is being taxed. And taxpayers with high medical expenses, casualty and theft losses, or state and local taxes have fewer resources than taxpayers with the same amount of income and smaller expenses or losses (all else being equal). Under this option, taxpayers would not be able to subtract those expenses from their taxable income.
Another argument against this option is that eliminating itemized deductions would disrupt many existing financial arrangements, especially in the housing market. Many homeowners have purchased homes under the presumption that they would be able to deduct much of the interest on their mortgages and their property taxes. Eliminating those deductions would make it more difficult for homeowners to meet their obligations. And such a change would also reduce the amount new homebuyers would be willing to pay, which would lower the prices of homes, on average. Lower housing prices would create further stress on the finances of existing owners.