Economics, Taxes and Spending

How the Tax Policy Center could improve its Romney tax study

Mitt Romney speaks to supporters in Iowa

Image Credit: Gage Skidmore (Flickr) (CC BY-SA 2.0)

Great political attention is being heaped on a new report by the Brookings-Urban Tax Policy Center (TPC) that claims to show that a Romney-style tax reform would end up shifting, in its most progressive form, $86 billion dollars per year from those making under $200,000 a year to those making more than $200,000 a year.

From this, the authors conclude that, “Any revenue-neutral individual income tax change that incorporates the features Governor Romney has proposed would provide large tax cuts to high-income households, and increase the tax burdens on middle- and/or lower-income taxpayers.”

As a tax policy researcher myself, I always welcome TPC’s analyses, and I found this report to be quite interesting as usual. Although their tax simulation model does not allow for the sort of dynamic scoring I’d like to see, it oftentimes provides very helpful insights. After giving the latest report some thought, though, a few aspects of it might have invited some of the false inferences from the left and harsh attacks from the right. Fortunately, with a few simple additions, a follow-up report—let’s call it my dream study—could clear up much of the confusion and build on the authors’ hard work in a way that would be very useful for the tax debate.

The first aspect that stands out is that Governor Romney has yet to detail what tax expenditures he’d repeal, but TPC assumes that many items are either “on the table” or “off the table.” While some of these assumptions make a lot of sense, others make less.

For example, a couple of items that TPC assumes are off the table are the exclusion of interest on tax exempt bonds and the exclusion of interest on life insurance savings. While Governor Romney has professed a desire to keep rates on savings and investment low, maintaining these exclusions is not necessarily what he meant. In fact, both of these exclusions largely benefit the wealthy, and, according to the Treasury Department, added together their repeal would net upwards of $90 billion that could be redistributed to lower-income individuals. That would go a long way towards balancing out the supposed $86 billion windfall for the rich and tax hike on the middle class and poor, and it could make the impossible suddenly possible.

While my analysis of those exclusions is nothing if not rough, TPC could do a much better job with the use of their model. So, my dream study would show all of the different combinations of items that could be included to make a revenue-neutral tax reform distributionally neutral rather than placing items either on or off the table and then claiming, given those assumptions, that distributional neutrality is impossible.

The second aspect of the report that could be modified is that TPC defines the rich just like the Democrats have chosen to do, with those earning more than $200,000 being called “high income” and those earning below that being called middle-class or poor. This arbitrary definition matters a lot to this analysis. If the definition of “high-income” were placed at, say $150,000 rather than $200,000 (which to me seems quite fair since both are many times my income), then the plan might appear to be a transfer from rich to poor rather than the other way around, or at least closer to neutral. In my dream report, it would be nice to see the break-even point for each of the different combinations of base-broadeners that TPC analyzes.

Lastly, TPC’s report offers scant documentation on how the different pieces of the tax reform are modeled and how individuals in different income groups would behave. Although it may take a little work, my dream study would provide results for a wide variety of these assumptions, or, at the very least, include a fat appendix that details the assumptions they use. This is particularly important for assumptions regarding growth and individual feedback effects because different economists, based on a broad literature, have different views that imply divergent revenue and distributional outcomes. Due to its lack of documentation, TPC’s report, in a way, is only relevant for those economists who agree with their assumptions, and they don’t even know who they are because not all of the assumptions are clear. Moreover, the lack of documentation is quite misleading for non-economists who aren’t aware of these issues. My dream study would remedy that.

Overall, my conclusion from the report is the opposite of the claim made by President Obama in a recent campaign ad. He says Romney’s proposal is a tax cut for the rich. I say that I’m now more convinced than ever that pro-growth, revenue neutral tax reform need not be regressive. I’m hoping for a study from TPC that helps us do it.

5 thoughts on “How the Tax Policy Center could improve its Romney tax study

  1. The study did what it intended to do, so in the immortal words of Aerosmith: “dream on, dream on, dream until your dreams come true…”

    • I actually went through the .csv file linked to by the claim that ending the municipal bond and life insurance interest preferences would yield $90 billion. For 2013 (the first year that Romney could influence) every single bond interest preference I can find adds to $40.6 billion on personal returns plus $20.2 billion on corporate returns. The life insurance interest exclusion is $22.4 billion on personal and $1.7 billion on corporate. Ignoring the rather important facts that the TPC analysis was only talking about personal returns, not corporate, and that Romney also wants to reduce the corporate tax rate, a revenue loss not covered in the TPC analysis, I still come out $5 billion short of the $90 billion claimed above.

      So the answer is no – the $90 billion assumes no grandfathering. But the question of grandfathering of existing municipal bonds is very important. If they are not grandfathered, their value would drop significantly (in order to make their after-tax rate of return equal that of newly-issued bonds with a higher interest rate). This would harm balance sheets and generate capital losses for anyone selling them. This would offset some of the revenue gains from repealing the exclusion. If they are grandfathered, the actual revenue gain would be much less, because new bonds would make up only a fraction of the total interest income.

      Moreover, repealing the exclusion would increase the cost of borrowing for states and municipalities. This would result in state and local tax increases (offsetting some of the federal decreases) and/or state and local employment reductions, offsetting some of the job gains Romney claims for his policies.

      • I may be in error above about the TPC analysis not regarding corporate taxes – I missed footnote 3 which indicates they allocated corporate tax cuts to individuals in proportion to their income from capital.

        Nonetheless, the point about only being able to achieve the savings by refusing to grandfather existing municipal bonds, and implications of such a refusal, stands.

  2. I’m sorry, but even redefining “high-income” as above $150,000 does not qualify as appearing “to be a transfer from rich to poor rather than the other way around”. It would best be described as a transfer from “Extremely wealthy” to just plain rich. I hate to let down all the politicians out there, but the term “middle-class” and the ACTUAL middle class are 2 completely different things.

    I grew up in what was considered (at least at the time) a normal middle class family. It would have been a DREAM COME TRUE for our family to have an income ANYWHERE EVEN CLOSE to $100,000 a year. As for the definition of “poor”? I suggest politicians in Washington take a trip out to Flint, Michigan and literally go door-to-door to talk to people who are (for the most part) nowhere near even a $50,000 a year income level. You go tell someone who is truly living in poverty that they can get a job paying $40,000 a year and they would be ecstatic!

    The reality of what the MAJORITY of people in this country face is not even REMOTELY close to being summarized in this or any other “tax plan”. Our elected officials need to come to terms with the fact that the majority of Americans are living in poverty, that the “middle-class” they speak of are the MINORITY and not the ones being “crushed”, it’s those Americans living in poverty who are being crushed by things like the price of gas. I don’t see how the “middle-class” Romney speaks of are being “crushed”. Any “middle-class” that meets the income level of $100K to $200K a year can EASILY afford gas, food, as well as their own healthcare (even if bought privately and not through their employer). They need to change the definition of income levels to accurately reflect the condition of this country.

    By the way, “oftentimes” is 2 words!

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>