The Romney Plan: Winners and Losers

The Rom­ney tax plan uses some funny math

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:

1. Cut indi­vid­ual rates in all brack­ets by 20 percent
2. Elim­i­nate the estate tax
3. Elim­i­nate the alter­na­tive min­i­mum tax
4. Elim­i­nate addi­tional taxes on high income tax­pay­ers caused by the Afford­able Care Act (ACA, or Obamacare)
5. 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:

1. 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.
2. 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?),
3. 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.
4. 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).
5. Cap­i­tal Gains and div­i­dend taxes would be elim­i­nated for mid­dle and lower-​​income tax­pay­ers, and remain at 15 per­cent for higher incomes.
6. “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.
7. 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.
8. 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:

Or in terms of income level

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:

1. 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.
2. 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.
3. 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.
4. 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.
5. 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.
6. 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.

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