One Part of Mitt Romney's Tax Plan That Makes Sense

A cap on deductions could be a key element of tax reform, no matter who wins the presidency.

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Mitt Romney, center, smiles as he meets with small business owners during a campaign stop in Aurora, Colo., June 20, 2011.
Mitt Romney, center, smiles as he meets with small business owners during a campaign stop in Aurora, Colo., June 20, 2011.

If you feel like Mitt Romney's tax plan is a moving target, you're not alone — even tax experts feel that way.

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In the second presidential debate, Romney explained how he would lower tax rates without reducing the tax revenue collected by Washington, since the government can't afford any more giveaways that would add to the national debt. The trick would be to lower the deductions some people claim, so that the tax system is simpler, yet produces the same amount of revenue for the government.

In the past, Romney has suggested that the government could limit the total amount of deductions to $17,000. In the second debate, he raised the prospective limit. "Everybody gets — I'll pick a number — $25,000 of deductions and credits," Romney said. "You can decide which ones to use."

Tax experts generally like the idea of capping the total amount of deductions anybody can claim. It would help the government raise desperately needed revenue, and a cap on total deductions is easier for politicians to support than changes in specific deductions such as those for mortgage interest or charitable contributions. Since taxpayers subject to the cap would decide which deductions to use, politicians wouldn't have to choose which deductions to favor. That might also limit the battles with myriad interest groups directly affected by targeted tax changes.

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The problem for Romney is that no cap on deductions will be enough to offset the lower tax rates he is proposing. The basis of Romney's tax plan is a 20 percent cut in each of the six federal tax rates, plus the reduction or elimination of several other taxes. Overall, that would reduce federal revenue by about $500 billion a year. So he'd need to come up with that much through a cap on deductions for his plan to remain "revenue-neutral," as he insists it would.

The math, however, doesn't add up. "Capping -- or even eliminating -- itemized deductions will not come close to paying for Romney's tax cuts," writes William Gale of the nonpartisan Tax Policy Center (which some conservatives mischaracterize as a "liberal" group). "It would be a step toward financing, but much more will be needed." The Tax Policy Center found that in order for Romney to lower tax rates as much as he wants to, he'd actually have to raise taxes on most Americans, through other means, for his plan to remain revenue-neutral.

That fuzzy math has generated a lot of confusion about Romney's plan and exposed Romney to charges that he's simply fibbing. But if Romney were to become president and submit his tax-reform plan to Congress, real-world politicking might produce something that's more realistic. Romney's 20 percent cut in tax rates could be changed to a 10 percent cut or even a two percent cut, for instance, which would make the arithmetic more plausible and still allow Romney to claim that he cut tax rates for all Americans. He could also compromise on other parts of his plan, such as the elimination of the capital-gains tax for most taxpayers.

[READ: Mysteries in Mitt Romney's 2011 Tax Return]

Gale and other tax analysts, in fact, think a cap on deductions could be an important element of tax reform, regardless of who the next president is. Republican economist Martin Feldstein of Harvard advocates a slightly different type of cap amounting to two percent of every taxpayer's adjusted gross income. Feldstein says that could raise up to $250 billion per year — again, without forcing Congress to favor one type of tax deduction over another.

The majority of taxpayers don't itemize deductions on their returns, so they wouldn't be affected by a cap. About one-third of tax filers do itemize deductions. Of those, the average amount of deductions is $25,545, according to the latest data from the IRS. Higher-income filers claim more deductions, so they'd be the ones most affected by a cap. Those with incomes between $100,000 and $200,000, for example, claim an average of about $38,000 in itemized deductions. Those with incomes above $250,000 claim about $130,000. Whether their overall taxes went up or down would depend on the threshold for a cap, and also on how much tax rates changed.

A cap on deductions might also affect what people do with their money. Some people might buy less expensive homes to assure that their deductions for mortgage interest stayed below the cap. Wealthy taxpayers, who claim an average of about $18,000 in deductions for charitable contributions, might donate less if a cap reduced or eliminated their ability to claim a tax credit for those donations. Then again, Mitt Romney didn't claim all the charitable deductions he was entitled to on his latest tax return. Perhaps he's a model taxpayer after all.

Rick Newman is the author of Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.