One source of interest in a tax reform that broadens the base and lowers the rate is the potential increase in growth, as labor supply and investment respond to lower marginal tax rates. Yet, studies of a signature reform in the past, the Tax Reform Act of 1986, found little effect on growth. The act was revenue and distributionally neutral, which is a goal of some recent tax reform proposals. One reason advanced for the limited effects on growth is that the effects of provisions that broaden the base to finance lower statutory rates increase effective marginal tax rates for some taxpayers.
This report shows how options to broaden the tax base by placing limitations on itemized deductions can potentially work counter to the growth effects of reducing marginal tax rates, primarily through reducing labor supply. It also shows how these effects —along with other base-broadening provisions, such as slowing depreciation— limit the effects on investment and savings and can eventually reduce
the size of the capital stock in the economy. The effects on labor supply and the capital stock are considered in turn.
To examine the potential effects of base broadening on effective tax rates facing labor, the analysis examines provisions to eliminate itemized deductions for state and local taxes, for charitable contributions, and for both. It also examines provisions to eliminate itemized deductions altogether or to impose dollar caps ($17,000 and $25,000). …..