David R. Henderson  

Romney's Tax Cut

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There is a lot of controversy about Mitt Romney's proposal for cutting tax rates and broadening the tax base by limiting deductions and exemptions. I've discussed this here and here and Garett Jones highlighted Josh Barro's piece on it yesterday. Critics, including Barro, have concluded that the only way Romney can get his 20% across-the-board cut in tax rates, even with limits on deductions and exemptions, is to substantially raise taxes on the middle class. I highlighted Harvey Rosen's contribution to the debate here. The bottom line is that increasing taxes on the middle class is not the only way to achieve Romney's tax cuts. Now there's more to say, from three sources: the Tax Foundation, John H. Cochrane, aka, The Grumpy Economist, and Alan Reynolds.

The Tax Foundation has put out a study finding that Romney's tax cuts, even without the base-broadening, would, by improving incentives to produce, create tax revenues that would offset 60 percent of the static revenue loss from the cuts. I have not studied their study carefully, but it does not seem unreasonable. Then, it wouldn't be hard (economically, not necessarily politically) to cut deductions to make the tax change revenue-neutral. I've already highlighted Rosen's analysis of this.

John Cochrane highlights the Tax Foundation study. Here's how Cochrane puts his and the Tax Foundation's objection to "static scoring" of Romney's tax cut, the kind done by Josh Barro:

the point of a revenue-neutral, income-neutral tax reform is to permanently and predictably lower marginal rates, giving rise to incentives to work, save, invest, and increase economic growth over the long run.

What possible sense does it make, then, to evaluate such a plan by assuming off the bat that it has no effect at all on output, employment, investment and so forth? Yet that is precisely what the standard "static" scoring does! We build a rocket ship to go to the moon, and we evaluate its cost effectiveness by assuming that it never leaves the launch pad?


Of course, if you can show that the rocket ship can never leave the launch pad, that's a legitimate criticism of the rocket ship. But you can't just assume it. By the way, check out the comments, including Cochrane's responses to the commenters. Cochrane has some very good content there.

Finally, Alan Reynolds points out something I had missed in the first Obama/Romney rumble in Denver: that Romney did get more specific about cutting deductions. Here's what Romney said in the debate:

And I'm going to work together with Congress to say, OK, what -- what are the various ways we could bring down deductions, for instance? One way, for instance, would be to have a single number. Make up a number, $25,000, $50,000. Anybody can have deductions up to that amount. And then that number disappears for high-income people. That's one way one could do it.

Reynolds points out that Romney's plan is close to the Simpson-Bowles plan and Obama's is a movement in the other direction. Romney quotes economist Donald Marron, who was on the staff of the Simpson-Bowles Commission:
President Obama's National Commission on Fiscal Responsibility and Reform and the Bipartisan Policy Center's Debt Reduction Task Force (on which I served) both endorsed this strategy [of lower marginal tax rates on a broader base] in their recent deficit reduction proposals. The fiscal commission's "Illustrative Tax Plan" would scale back and redesign many of the largest tax preferences (e.g., mortgage interest, employer health insurance, and retirement saving), eliminate many others (e.g., state and local interest), and use the resulting revenue to

• Cut individual tax rates, bringing today's six brackets (10, 15, 25, 28, 33, and 35 percent) down to three (12, 22, and 28 percent);

• Repeal the alternative minimum tax (AMT), the personal exemption phase-out (PEP), and the phase-out of itemized deductions (Pease);

• Cut the corporate income tax rate from 35 to 28 percent.


After laying out the details of the Romney plan, Reynolds does a comparison:
When it comes to tax policy, the main difference between Romney's and Obama's National Commission on Fiscal Responsibility and Reform and Bipartisan Policy Center's Debt Reduction Task Force advisers is that Romney proposes 1) a slightly lower corporate tax rate, and 2) a much lower bottom rate of 8 percent rather than 12 percent. (The fact that there would be six rates rather than three is insignificant.)

Reynolds also points out:
Like most other news sources, The Economist (October 6) claims, "Mr. Romney has not specified which loopholes he would close." On the contrary, Romney has been quite specific that he would prefer a firm dollar cap on total deductions. This is a much tougher plan than the president's commission proposed, which cuts or caps some deductions but allows taxpayers to game the others. Romney's plan is even tougher than a proposal from economist Martin Feldstein, which would limit deductions as a percentage of adjusted gross income (AGI).

One qualification, though, not on the substance but on the identities of the players: whereas Reynolds writes that Marron is someone whom "President Obama appointed to advise him on such matters," I don't think that's true. The Simpson-Bowles Commission, not Obama, chose him.


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CATEGORIES: Tax Reform , Taxation



COMMENTS (14 to date)
KLO writes:
Of course, if you can show that the rocket ship can never leave the launch pad, that's a legitimate criticism of the rocket ship. But you can't just assume it. By the way, check out the comments, including Cochrane's responses to the commenters. Cochrane has some very good content there.

Yeah, but this is a two way street. While you cannot assume that Romney's tax cut plan will not increase growth over the baseline, Romney cannot assume that it will increase growth over the baseline either. Has he shown us any reason to believe that his proposal will increase growth as much as he says? If so, I haven't seen it.

Vanya writes:

Didn't the the TPC analysis include both dynamic and static scoring? Yet John Cochrane and Harvey Rosen seem to be saying that it was strictly static. Is their objection that the more widely-touted conclusions emerge more strongly from the static calculations?

Phil writes:

What I don't understand is the criticism from the political right that Obama's proposals are redistribution when that is precisely what Romney's proposals are. The only difference is who is the Peter that is being robbed to pay Paul. By lowering marginal rates and expanding the base in a revenue neutral fashion, there must be a redistribution from those who itemize on their taxes to those who do not. It might be a redistribution from mortgage payers to renters, from people in high income tax states to people in low income tax states, from the altruistic to the narcissistic. Why are these redistributions preferable to a redistribution from rich to poor?

I agree with David's argument about lower rates changing decisions on the margins, but is that not offset by the renter who is now discouraged from being a homeowner or the otherwise charitable person who now donates less? How are those economic effects counted or are they on the launching pad, too?

Mr. Econotarian writes:

Scoring for revenue-neutrality when we are facing a financial disaster should be static because we are no more likely to be able to model future growth properly than Obama's economic advisors could model the results of the stimulus on unemployment.

It certainly is not a bad idea to also score dynamically with various assumptions, but it should first work under static assumptions.

MG writes:

@Prof Henderson

Thanks for a very comprehensive roundup of some of the better supporters of the fundamental case behind Romney's proposals.

@Phil (but this really applies to many)

The opening line of the TF analysis is an admonishment to any who wants more from tax policy than just electoral non-sensense: "The debate over Mitt Romney’s tax plan has largely revolved around the short term concerns of who gets what and how much, rather than the more long term concerns of economic growth, job creation, deficit reduction, and tax reform."

I am not sure what "the right" is accusing Obama's campaign of doing, but if I had to accuse what passes as his tax proposals is that they are not at all aimed at achieving any of the the things the TF highlights. If that leaves "redistributive fairness" as the only residual, so be it.

Mike W writes:

Per KLO:

While you cannot assume that Romney's tax cut plan will not increase growth over the baseline, Romney cannot assume that it will increase growth over the baseline either.

True...especially if Tyler Cowan and the other "Stagnationists" turn out to be right. Cowan (I believe) referred to the "dangerous illusion" of assuming that the high rates of economic growth of the past will continue in the future. That assumption can be "dangerous" if we base policy on it and it turns out to be wrong.

Assuming lower tax rates will be offset by future growth might be such an assumption.

David R. Henderson writes:

@Mike W,
You're confusing changes and levels. Even if Cowen (with an "e") is right, the point is that whatever low growth we would have had without the Romney plan will be lower than the growth with the Romney plan.
As MG points out above, the Obama proposals would do nothing to increase growth and would, in fact, reduce it.

Mark Little writes:

The nice thing about smooth curves that peak is that they are fairly flat around the top. We may not know where the peak of the Laffer curve is, but that very uncertainty reflects low curvature--that is, a fairly small sensitivity of revenue to rates.

We may not agree on whether current top rates are to the left (as I think) or to the right of the Laffer peak, but we should be able to agree that the budget balance is less sensitive to tax rates than to changes in direct spending and tax expenditures.

That being the case, why not enjoy lower rates and focus concern on tax and direct spending?

Bruce writes:

One thing:

if deductions are capped at some income level, doesn't that effectively increase the marginal tax rate as the cap is approached???

Methinks writes:

Yes, Bruce. Deductions have no effect on the incentive to produce, though. If the mortgage interest deduction is capped, you may decide to buy a slightly different house or finance it differently but you will have no incentive to produce less because the tax on your income does not go up.

Romney's plan is, in part, an attempt to lessen the tax disincentive to produce. Or, I should say, to produce taxable income. He wants people like me (who are Obama's target) to stop figuring out ways to shield their income, abandon plans to take more time off and get back to growing our businesses. Obama thinks I'm going to continue to toil at the same rate and take the same risks for the Glorious State. Ha ha ha ha ha!

(in the interest of honesty, I'm not a big fan of Romney in general, but he at least sort of maybe understand that incentives matter).

Mike W writes:

@DRH

...the point is that whatever low growth we would have had without the Romney plan will be lower than the growth with the Romney plan.
As MG points out above, the Obama proposals would do nothing to increase growth and would, in fact, reduce it.

And that assumes the tax-tail wags the economy-dog...the historical comparisons thrown about by the tax-cuts-drive-growth folks have a larger element of coincidence than causation.

Methinks writes:

Coincidence, Mike W? Sure. Next year, when my tax rate is set to rise dramatically, I will coincidentally produce a lot less taxable income.

Incentives matter. Are you saying that no matter how much the state lowers the reward for the risk you take and the hours you work, you'll just keep plugging away at the same rate?

Tony N writes:

@Phil

One could argue that the deductions themselves are redistributive and thus eliminating them is anti-redistributive.

Thucydides writes:

Talk about wholesale elimination of deductions without specificity is problematic in that there can be a tendency to create a very high rate gross income tax, depending on what is done.

Further, many income tax "breaks" are designed to partially offset the negative economic effects of an income tax on savings and investment. Ideally, we would have a consumption tax, rather than an income tax, with exemptions or credits for low income people to deal with the regressivity issue.

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