Reforming ‘itemized deduction’ tax break could save millions, make state tax system less unfair
Itemized deductions cost Colorado millions of dollars in income tax revenue annually while undermining the fairness of state tax systems, a new report shows. Moreover, federal tax changes enacted during the past five years have gradually made itemized deductions more unfair and expensive, with tax cuts being passed only onto Colorado’s wealthiest residents even as the state faces unprecedented budget challenges. Itemized deduction reform could present one option for lawmakers to play a positive role in making Colorado’s tax system fairer and more sustainable while striking a better balance between making cuts to programs and services and closing tax loopholes.
A new report from the Institute on Taxation and Economic Policy, “'Writing Off' Tax Giveaways: How States Can Help Balance Their Budgets by Reforming or Repealing Itemized Deductions” presents estimates of the yield and tax fairness impact of five approaches to itemized deduction reform in the states, each of which would raise significant revenue to fund vital public services and make state tax systems less unfair.
Itemized deductions were designed to help defray a wide variety of personal expenditures that affect a taxpayer’s ability to pay taxes, including charitable contributions, extraordinary medical expenses, mortgage interest payments, and state and local taxes. Yet, the deductions undermine the fairness of state tax systems: Low-income families receive virtually no benefit from these deductions, and the biggest benefits are reserved for the upper-income families who arguably need them the least.
“We don’t think any lawmaker would intentionally devise a tax incentive to encourage homeownership that gives checks to only the richest taxpayers, while entirely excluding low-income families,” said Ali Mickelson, tax policy analyst for the Colorado Fiscal Policy Institute. “Yet itemized deductions have exactly that effect.”
The most comprehensive reform approach available to states is simply to repeal all itemized deductions and ensure that most middle- and low-income families are held harmless by simultaneously increasing the basic standard deduction available to all families, a step taken this year by the Rhode Island legislature. Repealing itemized deductions and significantly increasing the standard deduction in Colorado would result in a tax cut for 49 percent of the state’s taxpayers, yet the reform still would raise an estimated $183 million a year.
The report presents four additional reform options, most of which have been enacted in some form in a number of states: capping the total value of itemized deductions, converting itemized deductions to credits, enacting stand-alone phaseouts, and decoupling from the recent federal tax changes.
Mickelson said: “In the current fiscal and economic climate, Colorado’s policymakers need to consider all of the options available to them for generating revenue and closing our budget gap. Enacting sensible itemized deduction reform may be something to consider, especially to the degree it can help prevent federally-imposed tax cuts for the wealthiest few from affecting the budget while raising substantial revenues to fund needed public investments.”
The Colorado Fiscal Policy Institute is a project of the Center on Law and Policy, a nonprofit, nonpartisan research and advocacy organization seeking justice and economic security for all Coloradans.
Contact: Ali Mickelson
Tax policy analyst
303-573-5669, ext. 304
Perry Swanson
Communications director
303-573-5669, ext. 306