Question

What are the major tax deductions from adjusted gross income (AGI) that are allowed in calculating taxable income? What are the economic justifications for and consequences of allowing such deductions?

Answer 1

ANSWER

As per the given question,

STEP-1

There are two types of tax deductions from adjusted gross income- standard and itemized deductions Individuals have two options and he can claim either of these options. His decision depends on the fact which option reduces his tax the most. In standard deduction, fixed amount is deducted from the adjusted gross income depending upon his filing status. In itemized deduction, the individual itemizes the deductions (from Schedule A) and deducts them from adjusted gross income to get the taxable income.

STEP-2

List some itemized deductions and see their consequences 1. Medical expenses 2. State and local property and income tax 3. Interest rate payments 4. Charitable contributions

STEP-3

1. Medical expenses: This type of deduction item allows individuals to deduct medical expenses of an individual after reaching certain percentage of adjusted gross income. Like in 2013, the individual is allowed to deduct his medical expenses in excess of 10 percent of adjusted gross income This deduction is available to an individual because paying the medical expenses in excess of certain percentage decreases their well-being and their paying ability. As a result of this deduction, federal government allocates more resources in paying the medical bills of people which they could use in some other productive activities 2. State and local property and income tax: This type of deduction provides subsidies to the government and reduces the tax burden of the individual. The benefit to an individual depends on their marginal tax rate. It means higher income earners benefit more than the lower- income earners As a result of this deductions, federal government losses its tax revenues

3. Interest rate payments: Interest rates on mortgages of an individual for first and second home are tax deductible item. But this deduction will not apply on an individual if he takes the mortgage of amount greater than $ 1 million to buy or improve his first or second home or he takes the mortgage of amount greater than $ 100,000 for the purpose other than to buy or improve his first house. This gives subsidies to the individuals as in case of imputed rent deductions. It encourages the investments in housing. This increases the production of houses. People divert their resources from some other activities to the production of houses. 4. Charitable contributions: This type of deduction on one side reduces the tax revenue to the federal government. On the other hand, this type of deduction encourages the private expenditure and reduces the govenment expenditure because the private people or institutions are now contributing to charities and helping poor people. So, now government doesn't need to spend on poor people. This saves the government resources. They could use them in some other productive activities

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