The Romney Plan: Winners and Losers
Editor’s note: We always welcome article submissions from our readers. Today’s contribution comes from PWS.
The Romney tax plan has stimulated the sharpest and most entertaining exchanges among academics and policy wonks. Both camps, Obama and Romney, are able to use the very same papers to prove that the plan raises taxes on the middle class, or doesn’t, increases growth, or doesn’t, achieves revenue neutrality, or doesn’t. I’m surprised no one’s claimed it’ll bring Middle East peace, or won’t.
I can’t do justice to the debate in a single post, so in this one I’ll look at the Romney Tax plan and the first study that evaluated it, from the Tax Policy Center at the Brookings Institution.
The bare bones of the tax plan are to:
- Cut individual rates in all brackets by 20 percent
- Eliminate the estate tax
- Eliminate the alternative minimum tax
- Eliminate additional taxes on high income taxpayers caused by the Affordable Care Act (ACA, or Obamacare)
- Eliminate ‘tax expenditures’ to broaden base and keep the provisions ‘revenue neutral’. Tax expenditures include both deductions from and exclusions from income (e.g. both Medical Expenses and the preferential rate on capital gains).
Since the “bare bones” are all the Romney camp ever released, the various commentators have had to fill them in with reasonable assumptions. In particular, it’s not clear what the base is with respect to which it would be “revenue neutral”, no indication was given of what tax expenditures would be cut to make up the revenue shortfall, and although the plan promised no additional taxes on “middle income” taxpayers, the income floor was left undefined.
The Tax Policy Center (TPC) issued an analysis of the Romney plan August 1. Since detail was woefully lacking in Romney plan, the TPC made some reasonable assumptions:
- Lowering of corporate rates would be accompanied by reducing corporate tax expenditures by the same amount. Thus its analysis would only include individual income tax changes. However, as the TPC said, adding in the corporate tax reductions would make taxes more regressive.
- The Romney plan would not change tax expenditures for savings and investments, including capital gains, dividends, interest on state and local bonds, exclusion of gain on the sale of a home, non-taxed increase in value of life insurance policies (bet you never thought of that as a tax preference, eh?),
- The model assumes that all tax expenditures would be eliminated for the highest income level first, and only on eliminated lower income levels after they’ve been exhausted for the higher ones.
- The baseline used to measure is the “current policy” baseline: Permanent extension of 2001, 2003, and 2010 tax cuts and the phase in of the additional revenues in the ACA (Obamacare).
- Capital Gains and dividend taxes would be eliminated for middle and lower-income taxpayers, and remain at 15 percent for higher incomes.
- “Higher Income” is defined as above $200,000 per year for married taxpayers and $100,000 for singles. The Romney plan did not specify what he meant by high income taxpayers. $200,000 will cover about the top three percent of earners.
- Tax expenditures to be reduced (“on the table”) would be: Employer-provided health insurance and fringe benefits; exclusion of Social Security benefits, moving expenses, employee expenses, educational deductions and credits, medical expense deduction, state and local tax deduction, mortgage interest, charitable contributions, child and dependent tax credits, Earned income tax credit, child credit, various others.
- Tax expenditures “off the table” would include those listed above, and the step-up basis for assets in an estate.
Based on these assumptions, the net revenue reduction from the rate reduction would be $360 billion in 2015. Even eliminating all of the “on the table” expenditures from higher income taxpayers would leave a revenue shortfall of about $86 billion. To remain revenue neutral this shortfall would have to be pushed down to middle and lower income taxpayers.
The TPC concludes that the change in after tax income would be:
Percent change in after tax income
Or in terms of income level
Cash Income Level
Percent change in after tax income
In other words, the top five percent would pay lower taxes than today, and the bottom 95 percent would get a tax increase. The situation is even worse for households with children, because a lot of tax expenditures favor them.
TPC briefly considered how the “growth” effects of tax rate reductions would mitigate this situation. Their basic opinion is quoted from Alex Brill of the American Enterprise Institute (yes, the AEI, not exactly a den of liberal thinking) “lowering statutory tax rates while broadening the income base generally does not reduce work disincentives because it leaves the relevant effective tax rates unchanged”. Just what I would have said. But they did pass the changes through a model developed by Gregory Mankiw (now on the Romney economics team), a model which is quite generous in its growth assumptions. Even with these growth changes, there would still be at least a $33 billion shift in tax revenue from higher to lower income taxpayers.
A few observations:
- The study doesn’t show that a 20 percent across-the-board tax rate reduction could not be revenue neutral. It DOES show that it would inevitably increase the after tax income on higher-income taxpayers, and the higher the income the bigger percentage of income gain.
- Most important, this study considered changes in tax expenditures which are politically impossible, to show that even in that case revenue neutrality without higher taxes on middle and lower income taxpayers is mathematically impossible. For example, there could not possibly be a sudden cutoff of all deductions at $200K because the marginal tax rate at $199,999 would be astronomical, hundreds of thousands of percent. Look at the list of “on the table” items and imagine trying to eliminate them all, even for a small (but powerful and rich) minority of the population. Like I said, politically impossible.
- Thus the elimination would have to be phased in over income levels, which would push still more taxes into the middle and lower income ranges.
- This proposal eliminates the Estate Tax. I’ve said it before and probably will again. The estate tax affects only two to three tenths of a percent of each year’s decedents, and only very wealthy ones.
- Under any scheme for base-broadening, very high incomes have a much bigger percentage boost in their after-tax income than those farther down the scale, and at some point down the scale the effect is negative. Romney again seems to be serving the interests of his real constituency.
- In these studies the debate has been around the distributional effects of the proposed tax cuts. Since the budget is still far out of balance, and these proposals only at most get to revenue neutrality, it doesn’t help the deficit at all.
In my next article I’ll look at the counter and countercounter arguments this analysis generated, including Martin Feldstein, Harvey Rosen, and others. Stay tuned.
- Joint Tax Committee: Repealing Deductions Pays for 4% Tax Rate Cut (Not 20% Claimed by Romney)
- Romney and Obama Can Agree on Taxes. Why Can’t Congress? — Bloomberg
- Another study tries to undermine the central premise of the Romney tax plan — and fails
- Closing Tax Loopholes to Reduce the Deficit Is Tough But Necessary
- Tax Experts Show Why Mitt Romney’s Middle-Class Tax Cut Would Work
- Ryan Again Evades Specifics on Mathematically Impossible Tax Plan
- Bushonomics on Steroids: Romney’s Tax Plan Is Still Severely Impossible
- Paul Ryan Asked for Tax Math, Offers Gibberish
- The Final Word on Mitt Romney’s Tax Plan
- Economix Blog: The Math on the Romney-Ryan Tax Plan