The Agenda

Brief Note on the Romney Tax Proposal, or 2+2+n=5

Mitt Romney’s tax reform proposal aims to achieve a number of goals: 

(1) to cut all (explicit) marginal tax rates (MTRs) by 20 percent;

(2) to eliminate capital income taxes for households earning less than $200K and to limit them to 15 percent for all households;

(3) to curb tax expenditures, particularly for high-earners;

(4) and to raise as much revenue as current policy.

The Tax Policy Center released a report claiming that goas (1)-(3) can’t be reconciled with (4) without allowing for significant tax increases on middle-income households. The report was met with great fanfare, as you might expect. 

One small problem, as the TPC authors acknowledge, is that because the Romney campaign hasn’t been explicit about (3), the report made a number of speculative assumptions regarding (3). The authors maintained that they made the most favorable possible assumptions about (3), yet Curtis Dubay of the Heritage Foundation maintains that revising the tax treatment of life insurance, municipal bonds, and inherited wealth could close the gap. The TPC authors reject Dubay’s analysis, as Suzy Khimm of Wonkbook reports.

A bigger problem is that the TPC analysis doesn’t take account of behavioral effects. Romney’s critics have generally been dismissive of this line of thinking, e.g., Ezra Klein has written the following:

The common Republican response to estimates like the Tax Policy Center’s is that they ignore the growth-accelerating effects of tax cuts. To estimate those effects “would require a full analysis of the entire federal budget, the budget deficit, and the anticipated response of monetary policy to changes in the budget. Furthermore, estimates indicate that the effects of tax rate reductions on the macroeconomy are likely to be small or even negative, at least, over the typical 10-year budget window.”

Princeton economist Harvey Rosen has offered a somewhat different take (see here as well): he suggests that under realistic assumptions, the MTR cuts proposed by Romney could increase taxable income for high-earners enough to offset any need for tax increases on middle-income households. 

So when Matt Yglesias says that the Romney campaign is “saying that 2+2=5,” he’s not exactly right. The Romney campaign is saying that 2+2+n=5, with n=(the additional revenue captured from the increase in taxable income). If n=1, or some number greater than 1, we’re in the clear.

Matt concludes on the following note:

The Tax Policy Center has been doing the formal math, but intuitively it should be easy to understand. The different deductions have different distributive implications. If you eliminate a whole bunch of them, you’re going to skew the distributive impact of the tax code relative to the status quo. The good news is that you’ll raise a bunch of revenue to open up room for cuts in tax rates. But to maintain the status quo distributive impact, you’d have to fiddle with the rates very very carefully. A big 20 percent across the board cut isn’t going to work.

What is also important to understand, however, is that the TPC approach would not factor in the disincentive effect of much higher marginal tax rates, and so Romney’s tax plan would look much “better” if it, for example, cut MTRs by 20 percent for the bottom four brackets and raised them for the top two brackets to, say, 99.8 percent and 99.9 percent. I think we can all agree that this is not a very realistic assumption.

The obvious rejoinder is that the MTR cuts Romney has proposed are far smaller than the Reagan-era cuts, and so any impact on incentives is likely to be modest. That is an entirely fair point. Yet if Rosen’s analysis is correct, we wouldn’t need a particularly strong impact to shield middle-income households from tax increases.

I don’t endorse Romney’s tax proposal, as I’ve made clear in this space. Like David Koch, I think that there is a case for tax increases designed to raise more revenue than current policy as part of a larger budget deal. But the idea that n necessarily equals 0 or a negative number strikes me as weird. Romney’s critics would be on firmer ground if they stuck to arguing that the Romney plan won’t raise enough revenue to pay for popular entitlements.

One thing that depresses me about the debate over the Romney tax plan it has crowded out debate over the fact that the Affordable Care Act already appears to be exacerbating health care cost growth, possibly due to the rising market power of consolidated medical providers operating under relaxed antitrust restrictions. If ACA really does exacerbate health care cost growth, we will need much higher tax revenues that Mitt Romney or President Obama envision. 


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