This study examines the effect of allowing qualifying individual taxpayers that do not deduct any interest expenses on their tax returns (called quot;qualified saversquot;) to partially exclude their interest, dividend, and capital gain income, subject to a maximum exclusion. Meanwhile, taxpayers that elect to deduct interest expenses (called quot;net debtorsquot;) will continue to include all of their investment income in gross income. Unlike the current income tax system, which subsidizes borrowing and penalizes saving, the proposal neutralizes the decision to borrow or save for a significant number of taxpayers. Individuals that elect to deduct their interest expenses must continue to recognize their investment income. Taxpayers that elect to forgo their interest deductions can partially or entirely exclude their investment income. Using data based on IRS Public Use Tax Files, the paper considers three alternative exclusion ceilings: $10,000, $15,000, and $20,000 for joint returns and $5,000, $7,500, and $10,000, respectively, for other taxpayers. Taxpayers with investment income in excess of interest deductions are treated as quot;qualified savers.quot; Using these ceilings, the percentage of current individual taxpayers who would be eligible to exclude all of their investment income as quot;qualified saversquot; varies between 77 and 81 percent, depending on the size of the maximum exclusion. This means that the marginal tax rate on an additional dollar of new investment income or new debt will be zero for at least three out of every four taxpayers. The paper also investigates how the proposal can alleviate some of the distributional concerns associated with simplifying the taxation of social security benefits. The results indicate that the negative impact of taxing net social security benefits can be partially offset by simultaneously enacting the proposal. If the definition of investment income is expanded to include net social security benefits, then the average social security recipient at all income levels would not be adversely affected by a system that taxes net social security benefits. However, the revised proposal would have less impact on saving because more taxpayers would be subject to the exclusion ceiling
