Quick Note on Romney Tax Reform Scenarios

by Reihan Salam

As I’ve said on numerous occasions, I think a deep cut in the top marginal tax rate is a non-starter. Conservatives should be focusing on the fact that President Obama intends to raise the top marginal tax rate well beyond current policy. During the 2010 debate over extending the Bush-era tax cuts, Alan Viard explained what would likely happen:

Under the president’s proposal, the top bracket will rise to 39.6 percent. A stealth provision that phases out high-income taxpayers’ itemized deductions will also be reinstated, adding another 1.2 percentage points to the effective tax rate, bringing it to 40.8 percent. Wages and some of the pass-through income will also remain subject to a 2.9 percent Medicare tax. These 40.8 and 43.7 percent tax rates, which will apply in 2011 and 2012, match the 1994 to 2000 rates—the same top bracket, stealth provision, and Medicare tax were in place then.

But the picture changes in 2013. Under the healthcare law adopted in March, the Medicare tax will rise that year, from 2.9 to 3.8 percent. Also, a new 3.8 percent tax, called the Unearned Income Medicare Contribution (UIMC), will be imposed on high-income taxpayers’ interest income and most of their pass-through business income that’s not subject to Medicare tax. So, under the president’s proposal, virtually all of top earners’ ordinary income will be taxed at 44.6 percent, starting in 2013. We’re not just going back to the Clinton-era rates of 40.8 and 43.7 percent.

And there are some indications that the Obama administration will seek an even larger revenue increase from high-earners. Keeping the top marginal tax rate at 35 percent would, relative to this outcome, be a significant accomplishment.

Moreover, at least some congressional Republicans, including House Speaker John Boehner, expressed a willingness to contemplate revenue increases relative to a current policy baseline in the neighborhood of $800 billion. There is some ambiguity on this front, e.g., there was some discussion that a substantial share of the additional revenue would flow from an increase in economic growth. James Pethokoukis quoted a Republican aide who was involved in the debt ceiling negotiations back in July of 2011:

Despite what WH briefers may be saying, any new revenue in the framework would NOT have been generated by letting the current tax rates expire. That is simply false. Under the framework discussed, a CEILING was agreed upon that could generate $800 billion in new revenue over ten years. This would be done through comprehensive tax reform that would clear out deductions, credits, and loopholes in the system – and spur economic growth. [Emphasis added]

This leads me to a recent post by Dylan Matthews of Wonkbook, who cites two recent analyses of Mitt Romney’s proposed $25,000 deduction cap:

Despite its vagueness, Mitt Romney’s proposal to cap itemized deductions is prompting some insightful analyses from reputable think tanks. On Tuesday, Third Way released a report estimating that a $25,000 cap on deductions – the number Romney floated in that night’s presidential debate — would bring in only $730 billion over 10 years, a far cry from the $4.6 trillion needed for Romney’s tax cut plan to add up.

On Wednesday, the Tax Policy Center released numbers estimating that the cap would bring in $1.286 trillion in revenue over 10 years (more than Third Way’s estimate, but still not nearly enough to counterbalance Romney’s proposed tax cuts). The center also found that a $25,000 cap on deductions, combined with Romney’s rate cuts, would winding up lowering the tax bill for every income level.

Dylan goes on to explain that these amounts are not enough to balance deep cuts in marginal tax rates, which strikes me as obviously true. Yet it creates a few additional possibilities:

(1) If the cap generates $1.286 trillion, $800 billion could be devoted to deficit reduction and the remainder could be devoted to tax relief for middle-income households — ideally middle-income households with children;

(2) if we went with a $17,000 deduction cap, in contrast, TPC suggests that the federal government would raise $1.747 trillion. After putting aside $800 billion for deficit reduction, this would leave $947 billion for some version of family-friendly tax reform

If Mitt Romney is elected president yet Democrats retain control of the U.S. Senate, conservatives will have to get creative about how to break a potential impasse. But there is one critically important point to stress: any revenue increases should be tied to a reform of health entitlements. 

The Agenda

NRO’s domestic-policy blog, by Reihan Salam.