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SYEDA SABAHAT · #1 Thursday, August 30, 2012

ECONOMIST ARTICLES

Taking from the 19%, giving to the 1%

Mitt's maths

My tax plan actually does cut the marginal rates across the economy by 20 percent. I'm going to reduce and restrict deductions and exemptions at the same time. [That] and creating more growth will mean that the policy is revenue neutral.

—Mitt Romney, March 19, 2012

As Mitt Romney tightens his lock on the nomination, his economic proposals are getting more scrutiny. This week's print edition analyzes his economic platform and how his fiscal positions have converged with Paul Ryan's; an accompanying editorial urges him to flipflop away from his current positions on China and taxes.

Mr Romney himself drew more attention to his platform this week when he was overheard telling a group of wealthy donors that he might eliminate the tax deduction on mortgage interest for second homes, and on state and local taxes. This was notable because he had studiously avoided saying what tax expenditures (as deductions, exemptions and credits are known) he would eliminate to pay for his rate cuts. Matt O'Brien at The Atlantic and Deborah Solomon at Bloomberg View leapt on him for the pathetically small amount of money this would yield relative to the humungous cost of Mr Romney's corporate and personal tax cuts.

I think this is a bit of a sideshow. Mr Romney has repeatedly said his tax plan would be revenue neutral, and knows he will have to cut more than just those two items. It's cowardly of him not to say what those other things are now, but no more cowardly than the typical candidate for office. The odds of eliminating any tax break go down the more a candidate has to discuss it before an election.

The real question is, can Mr Romney plausibly produce a revenue neutral tax plan that cuts rates as much as he does? First, dispense with his claim that the tax cuts would partly pay for themselves by spurring additional economic growth. Official watchdogs like the Joint Committee on Taxation and the Congressional Budget Office don't count such “dynamic” effects because they are too small and ambiguous. They do sometimes count behavioral changes. For example, lower income tax rates might reduce the incentive for tax avoidance, causing households to report more taxable income. But those effects, according to Howard Gleckman of the Tax Policy Center, are also trivial.

That leaves us with the more straightforward question of whether he can finance his tax cuts just by eliminating tax expenditures. Donald Marron at the Tax Policy Center looks at the latest Treasury estimates (contained in the annual budget document Analytical Perspectives) and finds tax expenditures would be worth $1.5 trillion in 2015. My table nearby lists the major tax expenditures identified by the Joint Committee on Taxation and how much they would cost in 2015.

The first thing to note is that there are clearly enough tax expenditures to finance the $900 billion cost that the Tax Policy Center reckons Mr Romney's plan will cost (relative to current law). But as you dig into the list, problems arise. First, these expenditures would be worth a lot loss once Mr Romney has cut income tax rates (see my caveat below). Second, Mr Romney has put several off limits, most notably the preferential rate on dividends and capital gains (worth $91.3 billion) and the ability of corporations to defer tax on foreign income ($19.6 billion), since under his plan corporations would not owe taxes on such income. Third, several will presumably be off limits: is he really going to tax Medicare benefits ($79.3 billion) or eliminate the earned income credit ($58.5 billion)?

But the biggest problem is one not obvious from the table: the distribution of these breaks. Yes, they disproportionately benefit the upper 20% of households because their tax rates are higher. Nonetheless, as this Tax Policy Center paper notes, roughly a third went to the bottom 80% of households (especially tax credits and above-the-line deductions). Since Mr Romney has said he would spare the middle class, most of this money would be off the table. Where it gets really interesting is inside the top 20%. Many deductions are in effect capped. As a result, their biggest beneficiaries are not the top 1% but the next 19%, with one exception: the preferential rate on capital gains and dividends, more than half of whose benefits go to the 1%. By eliminating tax expenditures for upper income families except the preferential rate on capital gains and dividends, Mr Romney's plan would be a gigantic transfer from the upper middle class to the rich. And keep in mind that the upper middle class is also the group likely to pay most under any reform to Social Security and Medicare.

Mr Romney's team defends the feasibility of his plan by noting its similarity to the Bowles-Simpson commission proposal, which like Mr Romney lowers the top rate to 28% and pays for it by closing loopholes. But the comparison does not actually help Mr Romney's case. First, unlike Mr Romney, Bowles-Simpson eliminates the preferential rate for capital gains and dividends. That is both a significant revenue-raiser and the principal reason the truly wealthy suffer most under their plan: the top 1% sees its after-tax income fall 7.8% and shoulder half the net increase in taxes. Under any plausible version of Mr Romney's, the after-tax income of this group would rise. Second, it only lowers the corporate rate to 28% instead of Mr Romney's 25% (from 35%). Third, Bowles-Simpson clearly hurts the middle class; the middle 60% of households see their after-tax income drop about 1.5% each. The reason is that the plan nukes almost all deductions, and replaces only a few with miserly tax credits that are worth less than the current deduction to most taxpayers. If Mr Romney wants to spare the middle class he will have to be much more generous than Bowles-Simpson when it comes to protecting their tax breaks. And there's the rub: Mr Romney can be revenue neutral or he can spare the middle class but I don't see how he can do both.

Both Treasury and JCT value tax expenditures on "current law," which means they assume tax rates will go up as George Bush's tax cuts expire. This raises the value of the expenditures (since a tax break is worth more to someone paying a 39.6% tax rate than a 35% tax rate) as well as the cost of Mr Romney's plan. They would be worth far less assuming Mr Bush's tax cuts are extended, and even less with the much lower tax rates Mr Romney contemplates. Second, totaling tax expenditures may not equal their actual aggregage value because of interactions: eliminating one may make others more or less valuable. Third, for reasons I can't determine, JCT and Treasury estimates differ significantly, with the latter usually larger.

SOURCE: THE ECONOMIST

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