Romney's tax plan doesn't add up - but it deserves a second look

Reuters

Republican presidential nominee Mitt Romney speaks at a campaign rally in Davenport, Iowa October 29, 2012.

Article Highlights

  • Governor Romney is proposing a major tax reform plan with 3 main planks. Does it deserve a second look?

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  • The underlying analysis in TPC’s study on Gov. Romney’s tax plan is sound, but it’s far from the last word on the subject.

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  • If you tweak just one number (20%) in the plan, Governor Romney’s principles look very defensible. @MichaelRStrain

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Romney's critics are right: His plan -- with 20% cuts to rates -- would have to raise taxes on the middle class. But if you tweak just that one number, his principles (lower rates, fewer loopholes) look very defensible.

Governor Romney is proposing a major tax reform plan with three main planks: cutting marginal tax rates across the board, not adding to the deficit, and maintaining the existing progressivity of the tax code. Both his critics and many non-partisan writers and economists argue that his plan will result in a middle class tax increase. But that's not the only possible outcome. A fair reading of the Romney campaign's recent public statements suggests that the governor will be able to satisfy all three planks. Here's why.

The Tax Policy Center (TPC) was the first to argue that these three goals cannot be achieved under Governor Romney's plan. Their analysis is quite straightforward. Let's walk through it now.

Under Mr. Romney's plan -- reducing individual income tax rates by 20 percent across the board; eliminating the AMT, the estate tax, and the high-income taxes associated with Obamacare; and eliminating taxes on interest, dividends, and capital gains for taxpayers with AGI less than $200,000 -- the federal treasury sees a reduction in 2015 of $360 billion relative to the amount of tax revenue it would receive under current policy.

In order to ensure that these tax cuts don't increase the size of the deficit, Mr. Romney needs to close some loopholes and eliminate some deductions. He has promised to maintain current tax rates on interest, dividends, and capital gains for rich households. So the TPC naturally assumes that tax provisions targeted at savings and investment are off the table.

This leaves popular expenditures like the mortgage interest deduction, the tax-free status of employer-provided healthcare, the deduction for charitable giving, and the EITC. Eliminating all loopholes and deductions not targeted at savings would generate $551 billion in additional tax revenue. But only $360 billion are needed, so only 65 percent of the $551 billion have to go.

So far the TPC has just laid out the facts. But here the TPC makes a heroic assumption which actually biases their results in favor of Romney: they allow for all tax expenditures to be eliminated from households earning more than $200,000 before eliminating any tax expenditures from households earning below that amount. (It's virtually certain that a President Romney won't propose the complete elimination of deductions for any one income group.) It turns out that eliminating all deductions for the rich isn't enough to ensure revenue neutrality. Tax expenditures for sub-$200,000 households must be cut by 58 percent in order to keep the deficit from increasing.

The TPC concludes that the combination of a 20 percent rate cut and maintaining revenue neutrality requires that Mr. Romney raise taxes on the middle class.

The TPC's analysis jives with common sense: The rich would see a larger financial benefit from a 20 percent rate cut than they receive from all current loopholes and deductions, so cutting rates and paying for it with base broadening will make them better off. Since the rich don't enjoy enough loopholes and deductions to pay for all the across-the-board rate cuts, and since the deficit can't increase, the middle class has to pick up the rest of the tab.

Various analysts and economists have looked at the TPC study and quibbled with the details. It is true that if you assume tax reform will increase economic growth or if you assume that some deductions can be eliminated which the TPC kept in place then you can get to deficit neutrality without a middle-class tax hike. But the heroic assumption made by the TPC is hard to overcome with tinkering.

In short, the underlying analysis in the TPC study is sound, and it should be taken seriously. But it's far from the last word on the subject.

THE CASE FOR ROMNEY'S TAX PLAN

Mr. Romney claimed (1) that top rates would be reduced by 20 percent and (2) that the size of the deficit would not increase by one dollar and (3) that the share of tax revenue borne by the middle class would not increase by one dollar.

Perhaps because of the way the TPC report was written, Mr. Romney's critics assume that the first two will be literally enacted, requiring that taxes be raised on the middle class. This assumption lacks prudence.

Why? Because Governor Romney and his campaign haven't been hanging their hat on an exact rate reduction of 20 percent. If anything, over the last several weeks that's the item which they've stressed the least.

Here's Mr. Romney on Meet the Press, September 9th: "And so everything I want to do with regards to taxation follows simple principles, which is bring our rates down to encourage growth, keep revenue up by limiting deductions and exemptions and make sure we don't put any bigger burden on middle income people."

Here's Ed Gillespie, a top Romney advisor, on Fox News Sunday this weekend. Chris Wallace, the host, asked Mr. Gillespie why it is okay to tell voters that they will get a rate reduction of 20 percent but not tell them which deductions they would lose. When Mr. Gillespie responded that it is perilous to negotiate "in a campaign environment" because "you're going to lock" Republicans and Democrats into positions, Mr. Wallace responded: "You locked in on the 20 percent tax rate."

Mr. Gillespie's response: "The 20 percent tax rate, I think that people understand that that is a broad principle, that that tax rate needs to come down and we need to broaden the base. That's the principle. The principle is also that we're not going to change the share of taxes paid by upper income earners and we're going to give tax relief to the middle class and it's going to be deficit neutral."

Finally, it is worth noting that Governor Romney never mentioned the 20 percent figure in the first presidential debate.

It seems that the Romney campaign, including the governor himself, is talking about principles, and not the exact size of the rate cut. Mr. Gillespie is arguing that a "20 percent tax rate cut" is a way of communicating to voters a principle: that Governor Romney wants to significantly lower rates. But not in isolation -- the rate reductions will be accompanied by base broadeners in order to keep the tax reform both revenue and distributionally neutral. Governor Romney said much the same.

It is true that if you take Mr. Romney's three promises literally then something has to give. But it seems odd to assume that what will give is the promise not to increase taxes on the middle class, especially since the Romney campaign has been intentionally playing down the specific 20 percent figure.

Perhaps it is appropriate to slam Mr. Romney for his lack of details and to assume that his plan will result in an outcome that maximizes the election-year political benefit to his opponent. But this voter prefers a statement of principles and an absence of details over no comprehensive reform plan at all. We'll soon see if the plurality of Americans shares that sentiment.

 

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About the Author

 

Michael R.
Strain
  • Michael R. Strain is a resident scholar at the American Enterprise Institute, where he studies labor economics, public finance, and applied microeconomics. His research has been published in peer-reviewed academic journals and in the policy journals Tax Notes and National Affairs. Dr. Strain also writes frequently for popular audiences on topics including labor market policy, jobs, minimum wages, federal tax and budget policy, and the Affordable Care Act, among others.  His essays and op-eds have been published by National Review, The New York Times, The Weekly Standard, The Atlantic, Forbes, Bloomberg View, and a variety of other outlets. He is frequently interviewed by major media outlets, and speaks often on college campuses. Before joining AEI he worked on the research team of the Longitudinal Employer-Household Dynamics program and was the manager of the New York Census Research Data Center, both at the U.S. Census Bureau.  Dr. Strain began his career in the macroeconomics research group of the Federal Reserve Bank of New York.  He is a graduate of Marquette University, and holds an M.A. from New York University and a Ph.D. from Cornell.


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