The Agenda

Further Thoughts on the Romney Tax Proposal

James Pethokoukis writes:

Mitt Romney’s updated and enhanced tax reform plan has left some conservatives unenthusiastic, particularly over at National Review. Kevin Williamson writes that “Romney Whiffs on Income Taxes.” Ramesh Ponnuru and Reihan Salam both call it the “Bob Dole tax cut.” (I’m pretty sure that is not an endorsement.) By that, they mean the Romney plan lowers marginal tax rates—Dole called for a 15 percent cut back during the 1996 campaign—but keeps the same number of tax brackets. Romney would also scale back tax breaks, particularly for high incomers.

That’s actually not quite right — I was quoting Ramesh, so it’s more like “Ramesh Ponnuru called it the ‘Bob Dole tax cut’ and then Reihan Salam quoted him calling it the ‘Bob Dole tax cut,’ and then I quoted …” and so on. I wouldn’t have described the Romney plan as the “Bob Dole tax cut,” mostly because I don’t have a particularly strong recollection of Bob Dole’s 1996 tax proposal. What I can say is that Ramesh has offered a strong critique of the approach that Romney has embraced, most recently in a Bloomberg View column.

Pethokoukis also offers the following:

Reihan speculates that Team Romney didn’t endorse something like P-S because the supply-side Wall Street Journal wouldn’t like it. But it seems like there are enough moving parts here to satisfy everybody. Or maybe Team Romney couldn’t make the numbers balance to their liking. I dunno, though I look forward to finding out. But the Romney plan is a huge move in the right direction on tax reform, as Reihan notes. Look, if in 2017 the top income tax rate is 28 percent, the corporate rate is 25 percent, and the cap gains rate is 15 percent, I would be delighted. And, I think, so would most folks at NR.

It’s not clear to me that Team Romney devoted much attention to making the numbers balance, i.e., to make a plausible case that the new Romney tax plan is revenue-neutral or that it approaches revenue-neutrality when we account for dynamic effects. Josh Barro estimates that Romney’s proposed rate reductions will cut federal revenues on a static basis by $5 trillion over ten years:

Before base broadening, the plan could be expected to cut federal revenues by about $5 trillion over a 10-year period, compared to a policy of extending 2012 tax policy (except the payroll tax holiday) into the future.

On a static basis (that is, before estimating economic feedback effects from cutting taxes) Romney’s corporate tax cuts would cost about $1 trillion, a 20 percent across-the-board cut in personal income tax rates would run about $3 trillion, and then sundry other proposals (most notably, abolishing the AMT and giving capital gains tax relief to lower- and middle-income households) would cost about another $1 trillion.

Those numbers are not exact, and the campaign indicated on a press call today that it has a score which it plans to release in the future. But while the campaign’s number will surely deviate somewhat from $5 trillion, it will in any case be large.

As he goes on to explain, making this up through cuts to tax expenditures will prove very difficult. To get a sense of how difficult, consider the following from CRFB’s recent take on the Tax Policy Center’s report on “Curbing Tax Expenditures“:

Rather than focus on every tax expenditure, TPC focuses on seven of the largest tax expenditures — the mortgage interest deduction, charitable deduction, state and local tax deduction, deduction for medical expenses, exclusion for employer provided health insurance, and preferential treatment for capital gains and dividends. Together, these tax expenditures account for 40 percent of total tax expenditure costs. TPC then examines three possible reforms:

* Replacing each tax expenditures with a 15 percent credit (for capital gains and dividends, this would result in a 15 percent rate differential).

* Limiting the total individual value of these tax expenditures to 3.9 percent of income (similar to the Feldstein, Feenberg, MacGuineas Proposal).

* Applying a 39 percent across the board haircut to each tax expenditures.

Each of these cuts are meant to have the same effect on change in tax burden (which is measured statically*), though because of behavioral effects they raise different amounts of revenue. The conversion to the 15 percent credit would have the largest impact over the 2012-2021 time frame ($2,769 billion), followed by the 39 percent haircut ($2,426 billion) and then the 3.9 percent cap ($2,407 billion). On average, these policies would increase revenue in 2021 by about 1.5% of GDP.

For those of us who favor preferential treatment for capital gains and dividends, the landscape looks even more problematic. 

My preliminary assessment of the new Romney proposal was too generous. The Bush tax reform panel’s Growth and Investment Tax Plan was much, much better than the Romney proposal. Indeed, I’d like to see it implemented as is — the problem is that it is not as politically attractive, as it has a three-rate structure (15%, 25%, 30%) that on the surface looks like a tax increase for low and middle earners, though in fact its new Family and Work Credits ensure that the vast majority of low and middle earners will receive a tax cut. Moreover, the GIT, which really does achieve revenue neutrality, raises more revenue from the top 10%, the top 5%, and the top 1% of earners while maintaining very low capital income taxation.

As Alan Viard has argued, we have good reason to believe that high-income rate reductions tend to be the most growth-enhancing:

Although marginal-tax-rate increases are distortionary at any income level, rate increases at the top income levels generally create the largest distortions per dollar of revenue. That partly reflects the fact that the rates at the top income levels are already high, so further increases are more damaging. But it also reflects the fact that rate increases at the top raise revenue from only some of the affected taxpayers’ income. For example, consider a proposal to increase taxes by 5 percent of the income above $250,000 (which approximates the expiration of the high-income rate reductions for a married couple with ordinary income). The resulting revenue is less than 5 percent of the affected taxpayers’ incomes because the tax applies only to the income above the $250,000 threshold; for a $400,000 couple, for example, the 5-percentage-point tax increase applies only to the last $150,000 of income, and the revenue is only $7,500. Because the disincentive effects depend upon the marginal tax rate applied to the last dollar, though, they are as severe as if the couple had to pay an extra 5 percent on their entire income (except that the disincentive will not prompt the couple to reduce their income below $250,000).

The opposite pattern holds for tax hikes in the bottom bracket, which actually leave marginal rates unchanged for most of the taxpayers from whom additional revenue is collected. For example, suppose that the 10 percent bracket, which will apply to the first $17,000 of a couple’s taxable income in 2011 if extended, reverted to 15 percent. Taxpayers in that bracket would face a 5-percentage-point increase in ¬disincentives and would pay an additional 5 percent of taxable income. At the same time, all couples in higher brackets would also pay an additional $850 in tax because the first $17,000 of their income would be taxed at 15 rather than 10 percent. These higher-bracket taxpayers would not, however, face any additional disincentives because there would be no change in their marginal last-dollar tax rates.

This is part of why the GIT’s 15-25-30 rate structure is such an improvement over the current 10-15-25-28-33-35 rate structure. One could argue that Romney’s proposed 8-12-20-22.4-26.4-28 rate structure is in some sense “even better.” But Romney’s structure raises trillions of dollars less than GIT, so the comparison is somewhat misleading. 

Romney advisor Glenn Hubbard has offered one way to square the circle, as John Harwood reports: deep spending cuts:

Hubbard said three different revenue streams would keep the plan from increasing the budget deficit: the “dynamic” effects of economic growth, the additional income that would be subject to taxation through “base broadening,” and spending cuts Romney plans that would reach $500 billion per year by 2016. The campaign promised more specifics on those spending cuts within the next week.

I eagerly await the details. I quite like this idea theoretically, e.g., one recent estimate has suggested that reducing the productivity gap between the US public sector and private sector firms performing similar functions by half would yield savings between $300 billion and $600 billion a year. (I intend to write about this at greater length.) But this is an extremely tall order, it presumably reflects all levels of government rather than just the federal level, and it would involve a revolution in the terms of public employment. 

So in theory we could embrace the 15 percent credit approach to tax expenditures (and save $2.7T) and account for the rest through spending cuts and efficiency improvements. But this isn’t exactly cautious budgeting. 


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