September 11, 2012
Rosen: Growth, Distribution, Tax Reform, and the Romney Tax Plan
Harvey S. Rosen (Princeton University, Department of Economics), Growth, Distribution, and Tax Reform: Thoughts on the Romney Proposal:
Governor Romney has proposed a personal income tax reform that would lower marginal tax rates and broaden the tax base. Critics of the proposal have argued that high-income taxpayers would receive a tax cut, and given that the proposal is meant to be revenue neutral, this would inevitably lead to increased taxes for families with low and moderate incomes. Because the Romney proposal does not specify in detail just what tax preferences might be eliminated or scaled back in order to broaden the tax base, much of the debate over it has focused on what provisions would be politically and administratively feasible.
While this discussion has been illuminating in some respects, something seems to be missing. Relatively little has been said about the possible effects of the Romney proposal on economic growth. This is curious because increasing growth is the motivation for the proposal in the first place.
In this paper, I analyze the Romney proposal taking into account the additional income that might be generated by economic growth. The main conclusion is that under plausible assumptions, a proposal along the lines suggested by Governor Romney can both be revenue neutral and keep the net tax burden on high-income individuals about the same. That is, an increase in the tax burden on lower and middle income individuals is not required in order to make the overall plan revenue neutral.
(Hat Tip: Greg Mankiw.)
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Read the paper and then see if you can answer this question,
Is this a joke?
What you have here is the assumption that by lowering marginal tax rates, everyone's taxes will be reduced but the lower rates and the lower taxes will produce huge economic growth that will raise everyone's tax payments and hence the program is revenue neutral, just like the Bush tax cuts operated.
Of course the way the author gets to that conclusion is by assertion. The claim is that with lower marginal rates everyone will work harder and longer and rather than what they do today. Really.
Notice as you read through the paper the phrase "educated guess" appears. That is wrong, the paper is largely a "guess" but not an educated one.
To go back to Martin Feldstein's position, (a self-described key Romney adviser) it would take eliminating all deductions and causing employer provided health care benefits to be taxed and eliminating the child tax credit and eliminating the exemption of municipal interest from taxable income on all taxpayers with $100,000 or more income to make the Romney proposal revenue neutral. And even that is not correct due to errors in Mr. Felstein's analysis.
This paper is the equivalent of the following intellectual exercise.
Can pigs fly?
What if you assume pigs have wings then can pigs fly?
No - Assuming pigs have wings doesn't mean that they do have wings.
Posted by: David R. | Sep 11, 2012 5:00:08 PM
Mr. Reagan made the same assumption -- that lowering rates would increase growth enough to offset the resulting revenue loss. He was wrong. Mr. Bush (II) made the same assumption. He was wrong too. Mr. Rosen was Chair of the Council of Economic Advisers under Mr. Bush (II). We have much to thank him for already.
Posted by: Theodore Seto | Sep 12, 2012 12:14:48 AM
Well, I did read the paper. Rosen analyzes the impact of not just lowering rates, but broadening the tax base by eliminating deductions as well. David and Theodore, why do you misrepresent Rosen's analysis?
Posted by: Don | Sep 12, 2012 7:11:23 AM
Two interesting comments to start with. The first uses sarcasm and then begins to discuss details about a tax plan that has no details. To quote the author, is this a joke? The second makes an untrue assertion about the Reagan tax cuts which led to the largest economic expansion since WWII, including a tremendous increase in tax revenue to the federal government and completely ignores the fact that the Congress was spending money faster than the treasury was taking it in.
Posted by: Moneyrunner | Sep 12, 2012 7:22:52 AM
They were wrong? Let's look at what happened to federal income tax revenue under Reagan from 1983 to 1989, bearing in mind that Reagan slashed income tax rates across the board:
1983 -- $326 billion
1984 -- $355 billion
1985 -- $396 billion
1986 -- $412 billion
1987 -- $476 billion
1988 -- $496 billion
1989 -- $549 billion
Critics point out that Reagan also signed two tax increases. However, the fact remains that the total tax burden was far, far lower when Reagan left office than when he took office. In other words, even counting the two tax increases that Reagan signed, taxes overall were still much lower in Reagan’s last year than they were in his first year. For example, when Reagan became president in January 1981, the top marginal tax rate was 70%--yes, 70%--but by the last month of his presidency in January 1989, it was 28%.
As a result of the Reagan tax cuts, tax payments and the share of income taxes paid by the top 1% climbed sharply. For example, in 1981 the top 1% paid 17.6% of all personal income taxes, but by 1988 their share had jumped to 27.5%, a 10 percentage point increase. The share of the income tax burden borne by the top 10% of taxpayers increased from 48.0% in 1981 to 57.2% in 1988. Meanwhile, the share of income taxes paid by the bottom 50% of taxpayers dropped from 7.5% in 1981 to 5.7% in 1988.
Bush Tax Cuts: President George W. Bush’s 2003 tax cuts generated a massive increase in federal tax revenue and were followed by 52 consecutive months of economic growth. From 2004 to 2007, federal tax revenue increased by $780 billion, the largest four-year increase in American history. Total federal revenue from 2003 to 2007:
2003 -- $1.78 trillion
2004 -- $1.88 trillion
2005 -- $2.15 trillion
2006 -- $2.40 trillion
2007 -- $2.56 trillion
Total federal revenue for 2008 dropped slightly, down to $2.52 trillion, because a recession started that year, but revenue was still substantially higher than it was in 2003 or 2004. During the same period, income tax revenue rose dramatically, going from $925 billion in 2003 to $1.53 trillion in 2007. As with other types of federal revenue, income tax revenue dropped slightly in 2008, down to $1.45 trillion, due to the fact that a recession began that year.
Posted by: Cincinnatus | Sep 12, 2012 7:26:37 AM
Theodore: with Reagan's lowered tax rates, the revenue increased significantly. What also increased significantly was spending. Your statement is incorrect - revenue "loss" did not occur. The same thing occurred under JFK when he lowered the top marginal rates significantly.
Posted by: Bill H | Sep 12, 2012 7:33:42 AM
Didn't take long for the Obama campaign to get content-free "rebuttals" out.
Theodore -- actually, tax revenue increased after Reagan's tax cuts, as well as Bush's. And Kennedy's. Nice try, but some of us were alive then.
Posted by: Rob Crawford | Sep 12, 2012 7:33:52 AM
Tax receipts declined for the first three years of Reagan's term and then increased dramatically for the next five years. Under Bush they fell for the first two years and then rose every year till the recession took hold in 2008.
So apart from spelling their names correctly, you got every thing wrong.
Posted by: Chip | Sep 12, 2012 7:36:21 AM
Except, of course, both David and Theodore are wrong. This chart, for example, shows that in spite of actually defending the country and with Bush tax cuts fully in place, the deficit was reduced each year until the country was foolish enough to put Democrats in control of the Congress (Civics 001: they're the ones who actually pass the laws spending the money) in 2007.
The only question is their motivation: are they stupid or dishonest? I'll take both for a trillion, Alex.
Posted by: SDN | Sep 12, 2012 8:05:15 AM
The argument that federal income tax receipts rose after the Bush tax cuts is, unfortunately for those who support tax cuts because they increase income tax receipts, a factual issue. I say unfortunately because the data shows that simply did not happen.
For FY 2000 federal income tax receipts were $1.004 trillion. They were below that level for the next five years,and were $927 million in 2005,and that is before adjusting for inflation.
One can argue like Mr. Rosen that lower tax rates, will produce higher revenues, it's just that recent experience doesn't support that view, which is why, as I said, the argument is by assertion rather than facts or analysis.
Posted by: David R. | Sep 12, 2012 9:11:43 AM
>What you have here is the assumption that by lowering marginal tax rates, everyone's taxes will be reduced but the lower rates and the lower taxes will produce huge economic growth that will raise everyone's tax payments and hence the program is revenue neutral, just like the Bush tax cuts operated.
That is not the assumption. The assumption is that lowering marginal tax rates and reducing preferential tax expenditures (deductions) can be done in a manner which is revenue neutral (same total amount of taxes will be collected) and "keep[s] the net tax burden on high-income individuals about the same" (either as individuals or in aggregate, because what they gain in lower rates they lose in preferential tax expenditures).
Increased economic growth should be expected for several reasons. Lower tax rates foster an impression that there is less to be gained by energetic tax avoidance measures. Reduced preferential tax expenditures eliminate some means of tax avoidance outright, further discourage the quest for tax avoidance, and eliminate some economic distortions.
Posted by: Brad | Sep 12, 2012 9:56:20 AM
David R said:
"Mr. Reagan made the same assumption -- that lowering rates would increase growth enough to offset the resulting revenue loss. He was wrong. Mr. Bush (II) made the same assumption. He was wrong too. Mr. Rosen was Chair of the Council of Economic Advisers under Mr. Bush (II). We have much to thank him for already. "
If Bush was wrong, why were his deficits going down by 25% a year, to the point we would have been in surplus by 2009, had the housing bubble not popped?
Posted by: John | Sep 12, 2012 11:31:35 AM
Why can't lefties get it through their skulls that deficits come from spending, not insuffient tax revenue.
I'll never criticize Bush for the tax cuts. I will criticize his big spending.
Posted by: Old School Conservative | Sep 12, 2012 11:43:14 AM
David R. @9/11/12 5:00PM: Even when you take Rosen's 3% growth assumption out of the simulation, while leaving in the micro-behavioral changes, Rosen's still showing that the plan is slightly better than revenue-neutral for individuals with incomes over $200K. That's a pretty good rebuttal of the Brookings/TPC numbers.
Posted by: TheRadicalModerate | Sep 12, 2012 1:24:59 PM
Moneyrunner, could you let me know where you found those numbers? They don't quite match up with the numbers here: http://www.taxpolicycenter.org/taxfacts/displayafact.cfm?Docid=203. Thanks!
Posted by: Someguy | Sep 12, 2012 2:23:00 PM
All of this commentary ignores the basic fact that the paper (1) recognizes that in order to analyze going from tax system X to tax system Y one must know what X is and what Y is. Rosen himself says this and then goes on to say that like everyone else he doesn't know what Y is, and in fact doesn't even know what X is. Nevertheless after admitting he does not know the parameters of the old or the new regime he then goes on to analyze going from the old to the new. Read the paper, its basis is that the Romney plan is revenue neutral to positive because he assumes it is revenue neutral to positive. Really, how does that have any credibility.
The Feldstein analysis, explained here
at least takes a stab at assuming which preference items are changed, and even then because of errors in his analysis he does not get to revenue neutral. Of course, nowhere does Rosen say how long it will take to get to revenue neutral. Is it 5 years, ten years? The Bush tax cuts took over six years on an inflation adjusted basis to get back to the income tax revenue levels from when it started.
I guess if you have an unlimited amount of time economic growth and inflation will eventually get to revenue neutral, so in that sense the supporters of the program can say they will eventually be right.
Look, this issue could be easily settled, all Mr. Romney has to do is to release the details of his proposal. That he won't do so says this.
1. He doesn't know the all the details.
2. The numbers don't add up.
3. The details that he does know are politically unpalatable.
Yes, selecting all three answers is acceptable.
Posted by: David R. | Sep 12, 2012 2:50:18 PM