Economics, Taxes and Spending

The Tax Policy Center updates its Romney plan analysis

Gage Skidmore (Flickr) (CC BY-SA 2.0)

Gage Skidmore (Flickr) (CC BY-SA 2.0)

Yesterday, the Tax Policy Center published a paper with “FAQs and Responses” pertaining to their recent study on Governor Romney’s tax proposal. This new paper is quite useful and helpful, and the policy community should be grateful that they wrote it. However, as blemishes are apt to stand out up close, in a few ways this document highlights my misgivings regarding their initial study.

One of the document’s most useful contributions is the authors’ new analysis of the tax exclusions for municipal bond interest and interest on life insurance. In a recent blog post, I pointed out that these two exclusions would likely be “on the table” in a Romney reform package—and  the Wall Street Journal has recently verified this assertion by asking Glenn Hubbard, one of Romney’s top economic advisors. TPC, however, had assumed they were “off the table.” I went on to point out that eliminating these two exclusions could bring in “upwards of $90 billion,” much of which would come from those earning more than $200,000 a year, and I requested that TPC do a more thorough analysis.

To my great delight, they did. They found the value of these two exclusions to be $49 billion, $45 billion of which could be redistributed downwards. These numbers were derived from careful analysis that relied on assumptions consistent with those elsewhere in their study. The difference between the $49 billion that they find and my $90 billion, however, is primarily due to differences between those assumptions and mine: They assume that a rate-cutting corporate tax reform would be enacted simultaneously (eliminating some interaction effects), and that the revenue from eliminating the exclusions for corporations would not be included in the individual reform. For the sake of providing a rough upward bound, which seemed appropriate when discussing whether something is “mathematically possible,” I assumed neither.

TPC’s assumptions are reasonable, though, and accepting them brings us within $41 billion of distributional neutrality. That is awfully close.

First of all, there would be growth effects; maybe not by 2015, but they would come. As my colleagues Alex Brill and Alan Viard recently noted:

Governor Romney’s tax plan for individuals would lower statutory tax rates on ordinary income while leaving tax breaks for saving largely untouched. His corporate tax reform plan [which TPC is assuming] would further improve the allocation of capital and foster economic efficiency. Overall, the governor’s plan translates into a reduced tax burden on savings and investment, which are key drivers of long-run growth.

Growth would contribute more revenue to the government, thereby making base broadening easier. What’s more, there would be feedback effects at the individual level with individuals supplying more labor, making more investments, and thereby increasing their own income. TPC envisions some feedback effects, but possibly far fewer than other economists might. Growth and individual feedback effects could make up much if not all of the distance to distributional neutrality.

Secondly, any complicated tax model like TPC’s has a margin of error. Hundreds if not thousands of assumptions must be made, and each time you make one you accept the hopelessness of capturing reality. (Sometime try making the imputations necessary to calculate the distributional effect of repealing tax exclusions for employer-provided health care.) I’d be surprised if $41 billion is outside of the margin of error of TPC’s model.

Now, it’s worth noting that enacting the reform that TPC has modeled would be difficult both practically and politically. Practically, it would be difficult to eliminate tax expenditure from the top down–first for the rich, then for the middle class and poor. But policy tools that that have gained support on both the right and left–such as the caps for tax expenditures proposed by President Obama and Martin Feldstein–could be modified to roughly achieve this effect by setting different caps for different income levels. Politically, it would mean eliminating cherished tax expenditures. But Romney’s selection of Paul Ryan as running mate indicates to me that he is willing to discuss with the public–and work hard to convince them to support–policies that might at first be unpopular.

In the end, I think it might have been more constructive for the Tax Policy Center to write a paper showing how, and under what assumptions, Romney’s plan could work rather than showing how, under their limited assumptions, it doesn’t. But I am glad TPC continues to refine the analysis and work to explain their thinking. Tax policy is a complicated and imprecise science and the better the stock of analysis, the better the policy making process. Of course, the political process is something else entirely. Here’s to hoping that a campaign touting these results as “proof” of anything will start to back down now.

5 thoughts on “The Tax Policy Center updates its Romney plan analysis

  1. There are two additional barriers to eliminating the exemption for municipal bonds that you fail to note, plus potential offsetting revenue, growth, and employment effects. The first is the issue of grandfathering existing bonds. These bonds were offered at a lower-than-normal nominal interest rate with the understanding that the interest would be free of federal tax. A 28% haircut on the interest would lead to a fall in the market price of the bonds to align the new after-tax interest rate with the higher after-tax interest rate of bonds issued after this change in the law. To the extent that these bonds are sold before maturity, there would be some capital losses generated. However, if existing bonds are grandfathered, as I believe will almost certainly happen, the increase in federal revenue will be trivial at first, since the vast majority of the interest income will be from grandfathered bonds.

    The other barrier to this change in the law is opposition from state and local governments that will face approximately 1/3 higher debt service costs on all newly-issued bonds. This will lead to some combination of higher state and local taxes (partially offsetting the federal tax cuts) and reduction in government employment (offsetting some of the hoped-for employment gains from growth effects of the federal tax reform).

    I have to ask: if Romney is really so willing to have a courageous discussion of hard truths, why isn’t he doing it right now? All he needs to do is say out loud that he will definitely propose complete (no grandfathering) elimination of the municipal bond interest exclusion. If Congress listents to the lobbyists and keeps the exclusion or at least enacts grandfathering anyway, he can credibly shift the blame there.

  2. I ask you this, what will Romney’s first goal be 1) cutting taxes, or 2) eliminating cherished tax breaks to pay for tax cuts?

    My guess is answer (2), if elected with a mandate from the people first extend all the Bush tax cuts forever, then make permanent his 15% rate for capital gains and dividends and eliminate the AMT and the death tax.

    The politicians will fall over themselves to pass these long sought tax cuts.

    Romney will have cut taxes more than any American human living or dead and whether the expenditure cuts ever get done won’t really matter much to him or the rest of the 1%.

  3. The 2-4-8 Tax Blend is a tax reform plan that combines sales, wealth and income tax bases in ways that would not have been feasible just a decade ago. Mr. Romney’s tax reform outline supports a tax cut of at least 20% and low capital gains rates, but all options are on the table. In the past he has demonstrated the vision and guts to radically innovate by joining divergent ideas and ideologies (see Bain Capital, Romney Care, Salt Lake City). Perhaps it is just a coincidence that his most important primary endorsement came from net wealth tax supporter, Donald Trump (“The America We Deserve”, 2000) and his most important decision to date has been the selection of VAT supporter, Paul Ryan (“Roadmap for America’s Future” 2010). Unlike Mr. Obama, Mr. Romney seems to be the kind of man that will treat job creation and our economy with the determination of the 1939 Manhattan Project (and likely with the same level of secrecy). He spent enough years in France to learn the shortcomings of how its tax blend has been implemented. France imposes a net wealth tax on top of a progressive income tax (“soak the reach” method) rather than using the wealth tax to reduce the income tax rates (“coerce productive investment” method).

    A 2% net wealth tax (with exemption for $15,000 cash and retirement funds) could easily replace the job killing payroll taxes and enable the reduction of the income tax rate to 8% (and elimination of capital gains and estate taxes). A 4% VAT tax on business would also permit the corporate income tax rate to be reduced to 8%. Unlike the French, this new American Tax Blend would reflect a new tax code tax code with profound economic and incentives which resolve a dozen critical problems (i.e. job creation, wealth gap, long term Social Security funding, corporate tax reform, etc.) not considered by other tax reforms – all without increasing total tax revenue or government spending.

    The implementation of the 2-4-8 Tax Blend has no significant transition issues and is doable from a technical and administrative point of view. Politically the Tax Blend has much to offer both Democrats and Republicans. The wealth tax represents an ideal tax for the left while a low flat income tax represents an ideal tax for the right. Both taxes are needed to make the low rates work and this is fuel for political compromise and the elimination of all tax expenditures. The fact that rich and poor would pay the same low tax rates makes the issue of tax fairness difficult to argue by either side. Creating jobs and saving the economy may also motivate some in Washington to take a serious look.

    This is not the place to elaborate further upon the details of the 2-4-8 Tax Blend but they can be found in an article I wrote yesterday at the invitation of Forbes tax communist, Peter J. Reilly, titled “Creating New Wealth by Taxing Net Wealth”. All of this is mentioned for the benefit of Washington think tanks that all too often wildly extrapolate from tax outlines as if they were intended to be full tax reform plans while pretending to be non-partisan scholars. It is also offensive when economists act as if they are also experts in politics, psychology and law. They hurt their own credibility when they opine that the only way to accomplish something is for example, to reduce benefits, increase government spending, etc. There are many ways to solve our problems and the best is yet to come.

  4. This isn’t an “update,” and the glee Mr. Jensen is taking with Hubbard’s shell game is getting a little tired. ALL of these ideas have been floated at one time or another for DECADES. It’s old stuff. Each one has a consequence, politically or financially, that most people will not want to face.

    The joke of all of this- and it shows how hollow Mr. Hubbard’s finagling is- that in order to preserve the illusion of cutting taxes, Mr. Hubbard will simply impose them where they never were before to pay for them.

    It is very difficult for me to take this seriously. As it is, reducing marginal rates can be somewhat illusory. When a marginal rate is reduced, so too are the deductibility of mortgage interest (another shell being moved by Hubbard) local state and property taxes, and other deductions.

    We now have a situation in certain states where it is possible to pay more to the State and the County than one remits to the Federal government- this, without standing armies to maintain.

    The second part of Hubbard’s joke is that this plan of his is supposed to unlock the presenty barred door to new vistas of economic prosperity. Unfortunately, since there is no empirical evidence to back that up, this is nothing more than a rather silly exercise.

    The easiest thing to do is to simply RAISE the marginal rates, which effectively CUTS local taxes at the same time, and will restore the equilibrium we once had between the taxing authorities. Since it is the States and Localities who are living in a world of hurt, this is the most sensible venue.

    But it’s too easy and its too sensible, and it violates the Norquist Pledge, which is what all Hubbard’s shilly shallying is designed to do.

    Cutting a deduction is the same thing as raising a tax. Money is money.

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