At the beginning of last year, Congress passed a number of tax hikes to try and solve the current financial situation.
Unfortunately, the tax hikes were not enough to solve the revenue issues, which meant the budget woes would continue. After this, President Obama hinted that the next round of deficit-reduction steps would involve eliminating certain deductions and closing tax loopholes. While no specific details have been released about what those are, there are many experts who say there are a number of deductions that are at risk of seeing their demise.
There is one profitable option that has been presented and it is the taxing employer-sponsored health benefits. With nearly 150 million Americans receiving their health insurance tax-free, it is estimated that federal spending could be reduced by at least $150 billion each year over a five year period. This is based upon the average health insurance premium being $16,000 per family. If this benefit becomes taxable, however, some families may try to reduce the cost by going to plans with lower premiums. Unfortunately, this would cost them more in deductibles and co-pays. The government is already taking a look at this possibility by requiring employers to place on W-2 forms how much employees and the company are spending on insurance coverage. Whether or not it will happen is a good question.
Mortgage Interest Deduction
It is believed that the mortgage interest deduction is going to be one to go because it is one of the most popular tax breaks that people receive. It is also one that comes up in conversation quite often when figuring out ways to raise revenue. Due to the condition of the housing market, it is not likely that the mortgage interest deduction would disappear entirely, but it could be scaled back in a number of ways. One option would be to cap the amount of mortgage debt that a person can claim for the deduction. For instance, it could be scaled back from $1 million to $500,000. Congress may also only allow the deductions on primary residences and not secondary residences.
Another way this could be affected is by placing limitations on how much income a person has. This could happen because the tax savings are significant. Currently, the first-year deduction on a $400,000 mortgage is nearly $15,000 at a standard interest rate. This is an area where the low- to middle-income workers would benefit more than the higher earners.
State and Local Tax
State and local tax could also take a hit for those who itemize their deductions and tend to deduct the state and local taxes they paid during the tax year. In 2010, taxpayers deducted a total of $260 billion in state and local tax payments. This tax could also see the axe because there are already 4 million Americans who cannot take it because they are subject to the alternative-minimum tax. This one would be much easier for Congress to do away with since it is a deduction that many taxpayers cannot take advantage of.
There are many experts stating that the tax break for charitable donations could be coming to an end. It has been considered in the past as a way to reduce the federal deficit, estimating that such a cut could generate $20 billion in revenue. If it is not entirely eliminated, it is an area where there could be an income threshold. For instance, perhaps only those who contribute more than 2% or another percentage of their income would be able to deduct their charitable contributions.
However, there are critics of this strategy who say that donors could bundle contributions, which would mean they would give to charities every other year rather than every year in order to increase the odds of reaching or exceeding the minimum. Advocates for this say that it could encourage donors to boost how much they donate so they get the deduction.
Municipal Bond Interest
Investors in high tax brackets really enjoy municipal bonds because the interest is tax-exempt. It has been proposed that this tax be limited by capping the exemption amount for the wealthiest Americans. If the exemption would be capped at 28%, the taxpayers in the 35% bracket would have to pay 7% tax on the municipal bond interest. Many argue that reducing or eliminating this exemption entirely would push up the cost of borrowing because investors would demand an increase in the interest rates for owning the bonds. However, Congress may find it to be in their best interest to cut back on this major federal expense. By excluding municipal bond interest, the government could be looking at a $300 billion expense over five year. Instead, cutting back could result in money saved.
Corporate Tax Breaks
Because there are so many individuals who feel as if corporations do not pay enough in tax, it has been suggested by the president to close corporate tax loopholes. What has been heavily debated is how to handle the nearly $1.7 trillion that U.S.-based multinational companies have declared as foreign investments. Many critics say that taxing this cash could have a negative impact on the companies, which would have a negative impact on the economy. The negative economic impact would come in the way of companies not investing in markets outside of the United States that have high growth potential. Plus, a lot of the foreign cash held by U.S. companies are invested in U.S. banks and government securities. If that money were taxed, companies may have to use the money for other reasons rather than investing in those very important securities.
As you can see, there are pros and cons to these possible tax breaks. It will be interesting to see what happens as the debate heats up as to what is cut and what is simply cut back. Either way, there will be many Americans affected. They will not be able to take deductions that they may be used to taking, resulting in them paying more tax than they did when some saw an increase in the percentage of tax that they pay.