A Lower Standard Deduction Hurts Low-Income Filers & Boosts the Tax Prep Industry

Fact-based, data-driven research and analysis to advance democratic debate on vital issues shaping people’s lives.
Center for Economic and Policy Research
1611 Connecticut Ave. NW
Suite 400
Washington, DC 20009
Tel: 202-293-5380
Fax: 202-588-1356
https://cepr.net
Amid the Trump tax cuts’ many regressive policies, one move was a boon to working-class households. The standard deduction1 for federal income taxes was nearly doubled in the 2017 Tax Cuts and Jobs Act (TCJA). By making itemized deductions less viable and reducing taxable income by a sizable amount, the higher standard deduction was good news for low- and middle-income filers. With the increased standard deduction set to expire next year, we are at risk of returning to a status quo that only benefits the tax preparation industry. It is important to understand the disproportionate impact that a sudden drop in the standard deduction would have on working-class households.
Data Analysis
This analysis is interested in tax liability, which represents the amount a household owes in federal income taxes for a year. This is not the amount you owe after filing taxes; this is the amount the government says you should have paid over the course of the year.
This analysis aims at comparing tax liability under a higher and lower standard deduction, then relating that difference to the household’s annual income. Using IRS data from 2017 (the tax year preceding the TCJA) and 2021 (the most recent year for which the IRS offers detailed data),2 I compare households under two scenarios, with all else equal:3
Consider the following example: a married couple earning $60,000 annually with no incentive to itemize deductions.
This household occupies the 12 percent tax bracket in either case. Tax savings under the current system are $1,285 — roughly 2.1 percent of their annual income. Compare this to a married couple earning $600,000 annually with $30,000 in property taxes and mortgage interest to deduct. For the latter household, the higher standard deduction is irrelevant because they will itemize regardless.
The above example is purely illustrative, but we can use actual IRS data to extend this analysis. A representative household from each income group was systematically determined from each group’s average AGI (Adjusted Gross Income) and the likelihood of itemizing deductions in 2017 and 2021.6 Therefore, this analysis captures the impact on the typical household in each income group, rather than an aggregate impact. Of course, some millionaire households benefit slightly from the increased standard deduction, but they are far from the norm.
Table 1 shows the results of this analysis for the two most popular filing statuses. Among single filers, notice that 11 million people had income between $50,000 and $75,000; the typical household in that group saves 1.9 percent of its annual income with the higher standard deduction.7
Table 1
Figure 1 visualizes the pattern shown in Table 1. The general trend is the same for both kinds of filers. Low-income filers benefit more, as a percentage of income, from the increased standard deduction than high-income married filers do. With the higher standard deduction, the married couple making $25,000–30,000 saves 3.7 percent of their income, while the married couple making over $500,000 sees no change in their tax liability. A similar story applies to single filers; those making below $75,000 clearly benefit more from a higher SD than those making six figures.
Figure 1
The increased standard deduction makes itemizing unviable for many tax filers, which represents another important benefit of the change. Table 2 shows that 44.5 percent of married filers in the $75,000–100,000 income range opted to itemize in 2017, while only five percent of those filers itemized in 2021.
Table 2
When itemization is more viable, taxpayers are more likely to solicit costly tax preparation help. Research shows that this industry has been growing in recent decades, and the costliness of such services means wealthier households are much more likely to claim all their potential deductions.8 Many of these paid preparation services are unregulated, and their errors result in major headaches for filers and the IRS alike.9 Discouragement of itemizing means millions of working-class households no longer need to turn to the tax preparation industry.
Conclusion
We know the federal income tax is not the most effective way to tax the rich. With so much of the spoils of corporate power stowed in wealth and retained earnings, we need a multifaceted approach to reduce inequality. However, the planned dilution of the standard deduction next year would have disproportionate consequences for working-class households. Though the TCJA was rife with provisions that were regressive or complex,10 the increased standard deduction is progressive and easier for the average taxpayer. Congress must consider the distributional impact of a lower standard deduction, and how the added incentive to itemize is a giveaway to the tax preparation industry. A tax system that discourages itemization is a simpler and more just tax system.