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Wednesday, October 3, 2012

Tax Foundation: Romney Plan Would Cut Middle Class Taxes (Using 1% Dynamic Scoring Model)

Tax Foundation logoTax Foundation:  Would the Romney Tax Plan Necessarily Reduce After-Tax Incomes for the Middle Class?:

In August, the Urban-Brookings Tax Policy Center (TPC) released a report [updated here] claiming to show that Mitt Romney's tax reform plan would necessarily raise taxes on middle-class taxpayers and reduce their after-tax incomes, while giving a significant tax cut to high-income taxpayers. This conclusion is based on a distributional analysis that assumes Romney's revenue-neutral tax reform plan, which includes an across-the-board 20% cut in marginal income tax rates and an elimination of the alternative minimum tax, would require a significant reduction in most tax expenditures, including most notably the child tax credit, mortgage interest deduction, state and local tax deduction, and the exclusion of employer-provided health insurance.

This TPC study showing Romney's tax plan as "raising taxes on the middle-class yet cutting taxes for the rich" has generated quite a bit of attention. Some economists such as Martin Feldstein and Harvey Rosen have taken issue with the study, arguing that Romney's tax plan would not necessarily require raising taxes on the middle class.

One shortcoming of the TPC paper pointed out by Rosen is its "static" nature, meaning it fails to account for any income growth effects from the tax reform plan. Most economists would agree that revenue-neutral tax reform like that pushed by Romney would reduce economic distortions in the tax code and thereby increase economic efficiency and incomes by some degree over the long-term. Furthermore, unlike tax cuts that require debate over the economic effects of their financing, revenue-neutral tax reform does not need financing. In fact, if the plan was revenue-neutral on a static basis, it would likely raise revenue because it increases the size of the overall income tax base in the long-run.

[I]f one assumes a 1% dynamic income growth effect under Romney's plan (as interpreted by the TPC), then low-and-middle income earners would experience a slight increase in after-tax income as opposed to a decrease. A more modest growth of less than 1% would imply a decrease in after-tax income for low-and-middle-income earners, but a more robust growth of more than 1% would imply a substantive increase in after-tax income.

Update:  Tax Foundation: Simulating the Economic Effects of Romney’s Tax Plan:

While the debate over tax reform has been consumed with distributional issues, the economy continues to limp along in the worst recovery since the Great Depression. To be sure, this economy faces headwinds that even an ideal tax code will not address, but pro-growth tax reform can provide substantial benefits. Our results indicate that by lowering tax rates on investment and labor, the Romney tax plan would grow the economy by 7.4%, the capital stock by almost 19%, wages by almost 5%, and hours worked by 3%. The benefits would be widely enjoyed, as every income group would experience at least a 7% increase in after-tax income. It would benefit the federal budget as well, in that fully 60% of the static revenue loss from Romney’s plan would be recovered from taxing a larger economy.

http://taxprof.typepad.com/taxprof_blog/2012/10/tax-foundation-romney-tax-.html

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Comments

One wonders how long, just how long the myth that tax cuts will pay for themselves and that statements like

"Most economists would agree that revenue-neutral tax reform like that pushed by Romney would reduce economic distortions in the tax code and thereby increase economic efficiency and incomes by some degree over the long-term."

which are patently untrue will last. Here is Gregg Mankiw, who called people who present this stuff "charlatans and cranks".

http://gregmankiw.blogspot.com/2007/07/on-charlatons-and-cranks.html

and he is a Conservative and Romney supporter. As for the reference to Martin Feldstein, well his first analysis was wrong, as even he admitted and his later analysis had to argue that you would have to eliminate all of the deductions for anyone making over $100 k, and he is still wrong (then you would still not be revenue neutral because he left out such things as the standard deduction) as this site points out.

http://dismalpoliticaleconomist.blogspot.com/2012/09/romney-economics-adviser-martin.html

The core of the Romney plan as we know it today is this

"Assume my tax proposal is revenue neutral, then . . . . ."


Posted by: David R. | Oct 3, 2012 1:39:53 PM

However, the historical trend is quite clear: increases in aggregrate income are overwhelmingly captured by the wealthy. So even if the Romney plan would "increase economic efficiency and incomes by some degree over the long-term" (which itself is so dubious that the authors have to include the weasely "some degree" and allow themselves the "long-term" to establish any such effects), there is no reason to think that middle-class taxpayers would share in the increased income.

Posted by: Anonymous | Oct 3, 2012 3:23:11 PM

David R,

You don't really know what you are talking about. The Mankiw reference is about tax cuts paying for themselves in the form of higher revenues. The Tax Foundation report said nothing to that effect...it said incomes would grow. Incomes are not revenue.

It's just a simple statement that incomes grow from tax reform that broadens the base and lowers the tax rate.

I love when people claim to be the smart ones correcting others when they don't know what the heck they are talking about.

Posted by: AZ | Oct 3, 2012 7:52:08 PM

AZ and Others

The Romney plan has two stated characteristics, it is to be revenue neutral and it supposedly does not raise taxes on the middle class. As TPC and about everybody else has pointed out, only one of these goals is attainable. Either a 20% tax rate cut with a reduction in tax preferences program does not raise taxes on the middle class or it is not revenue neutral. To say otherwise is simply argument by assertion.

The only way the Romney plan can be both is under the argument that by lowering marginal rates incomes are increased and the resulting increase in revenues offsets the lower tax rates. Here is the quote from the Tax Foundation post from this blog.

"if the plan was revenue-neutral on a static basis, it would likely raise revenue because it increases the size of the overall income tax base in the long-run."

The Tax Foundation is clearly one of the 'cranks and charlatans' Mankiw was referring to.

The major tax system in the United States is an income tax. If incomes go up, tax revenues go up. Saying one increases is saying the other increases, it is a direct relationship. It is likely the reason the Tax Foundation focuses on incomes going up rather than stating revenues will go up is to confuse people and to avoid the problem of taking a position that tax cuts or reducing marginal rates pay for themselves.

At very high marginal rates that may be true. At current rates, they don't. Let me take you through an illustration using the latest idea of Mr. Romney, to limit itemized deductions to $17,000.

If you take the $17,000 cap, and if you run tax simulations (as I have done) for three different income groups, high income taxpayers who itemize, middle income tax payers who itemize and low income/seniors who do not itemize you learn the following.

1. In general taxes do not go up for high income tax payers. Of course, not, Mr. Romney is adamantly opposed to raising taxes in high income/high net worth tax payers, hence the opposition to allowing the Bush era tax cuts on those making more than $250,000 to expire.

2. In general, taxes do not go up for middle income tax payers who itemize. If one accepts that the plan is not revenue neutral Democrats are wrong to say otherwise. Of course what they say is that if the plan is to be revenue neutral middle income taxes must go up, which is a true statement.

3. Taxes will absolutely go down for low income/seniors families who don't itemize, as their rates are reduced by 20% and they are not affected by the $17,000 cap on itemized deductions. Their taxes have to go down, it is a mathematical certainty.

So if nobody's taxes go up, and one group has their taxes go down the plan cannot be revenue neutral.

These are facts and logic, not spin and assertion. Don't believe it, run the simulations yourself. Then tell us how a plan that does not raise taxes on high income groups, does not raise taxes on middle income groups that itemize and lowers taxes on low income groups/senior citizens who do not itemize can be revenue neutral without relying on the argument Mankiw said is made by cranks and charlatans.

Posted by: David R. | Oct 3, 2012 9:13:05 PM

David still doesn't understand. Romney's tax plan is revenue neutral on a static basis. Mankiw was talking about overall tax cuts paying for themselves, not tax reform packages that have both rate reduction and base broadening.

Posted by: AZ | Oct 4, 2012 6:37:54 AM

AZ is correct. I and everyone else do not understand how a tax plan which keeps taxes on the high income groups and some middle income groups the same and lowers taxes on the rest of the income groups can be revenue neutral on a static basis.

How does 0 + X = 0 when X is a negative number? The answer, it doesn't.

Posted by: David R. | Oct 4, 2012 9:01:12 AM

Again, David R. doesn't understand it.

The Tax Foundation report doesn't say that Romney plan lowers taxes on every income group. It simply says that after-tax income goes up for each group (as a whole), thanks largely due to the assumed 1% growth in pre-tax incomes. The dynamic revenue portion isn't that great -- just $25 billion. In fact, there is a methodology that discusses this.

Posted by: AZ | Oct 4, 2012 12:22:40 PM