Big Spending Republicans

Most voters seem to agree that Mitt Romney would do a better job of taming the debt. He certainly talks a lot about it. During the primary season he said that borrowing money to finance disaster relief would be “immoral” and that such activities should be left to state and local governments or the private sector (not sure how that would work). And his running mate. Paul Ryan, has garnered a reputation as a budget hawk.

But the historical record is not encouraging for deficit hawks.  Republicans have been good at cutting taxes, arguing that the problem is not inadequate revenues but too much spending. Obviously, the next step is to cut spending, but they have done a poor job on that front.

My former Urban Institute and Tax Policy Center colleague Gene Steuerle has put together a fascinating time series of spending change by presidency, measured as a share of GDP.  The chart above shows the data for domestic spending–that is, excluding defense and interest on the debt. Through the Clinton years, the top four presidents are Richard Nixon, Herbert Hoover, Dwight Eisenhower, and George H.W. Bush–all Republicans.

The most fiscally responsible president by this metric is a surprise: Franklin Delano Roosevelt.  Here is Gene’s explanation:

[T]he liberal New Dealer, Franklin D. Roosevelt, is at the bottom of the list. Domestic spending actually fell by 3.6 percentage points of GDP during his tenure. How can this be? The massive World War II defense build-up crowded out domestic spending. … Perhaps more importantly, FDR’s New Deal programs were primarily short-run or counter-cyclical in nature, and focused on unemployment compensation and jobs. Much of the spending was not intended to be permanent [and disappeared when the economy recovered from the Great Depression] … Non-cyclical programs, such as retirement and health, remained quite small. Even at the end of the Truman administration, domestic spending was 1.6 percentage points lower than it had been when FDR took office two decades earlier. Finally, much of the increase in domestic spending in response to the Depression occurred prior to Roosevelt’s presidency, under Hoover.

The only Republican true to stereotype is Ronald Reagan, who cut domestic spending by 2 percent of GDP.  The other big post-World War II spending cutter was Bill Clinton, who cut domestic spending by 0.6 percent of GDP.

Gene also gave me data for George W. Bush and Barack Obama, whose spending records are complicated by the response to the Great Recession.  From beginning to end of President Bush’s term, spending increased by 5.6 percent of GDP. which would give him the all-time lead if included in the chart.  But even if we stopped the clock at the end of fiscal year 2007, before the recession hit, he increased domestic spending by 0.7 percent of GDP.

Through FY2011, President Obama actually cut domestic spending slightly from the very high levels at the end of the Bush administration, and spending has been cut further since then.  Given the slowness of economic recovery, that was probably a mistake, but it certainly suggests that the image of the President as a fiscal profligate is not entirely deserved.

Of course, the effect on the debt depends also on defense, tax revenues, and interest. The chart above shows the debt record of presidents since Eisenhower.  (I exclude FDR, who borrowed heavily to finance World War II, and Truman, who benefited from an enormous peace dividend, because they are both outliers by a wide margin.)  Four of the five biggest borrowers were Republicans.  Ronald Reagan more than made up for his domestic spending cuts with large tax cuts, a defense build-up, and large interest payments on the debt.  President Obama wins biggest debtor honors, by a small margin over his predecessor, because of the combination of large outlays to fight the recession and tax revenues at the lowest level since the Truman Administration.

What lessons can we learn from this history?  If President Obama wins reelection, his domestic spending path is likely to follow FDR’s, declining as the economy recovers. Even if he had dreams of significant new domestic spending programs, it is unlikely that the Republican-controlled House would accommodate them.  Revenues will rebound with the economy and the president has proposed some other tax increases on high-income households.

What if Governor Romney is elected president?  The fear is that he will follow the course of George W. Bush–enact significant tax cuts and then lose interest in the politically challenging work of cutting spending.  The governor has been maddeningly vague about how he’d offset the cost of his tax cuts–which he promises will not increase the deficit–and he’ll have to take on much bigger items on the spending side than Big Bird.  It’s even possible that the bipartisanship he promises will amount to trading spending increases favored by Democrats for further tax cuts, not a good deal for the government’s balance sheet.

I don’t have a crystal ball and it’s possible that Mitt Romney’s fiscal stewardship will live up to his campaign promises. But history suggests that they should be taken with a big dose of skepticism.

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More Than Half a Million Farmers Didn't Pay Income Tax in 2007

DES MOINES, IA - AUGUST 08: Republican presidential candidate Mitt Romney tours a corn field with Iowa Secretary of Agriculture Bill Northey (R) and farmer Lemar Koethe on August 8, 2012 in Des Moines, Iowa. (Image credit: Getty Images via @daylife)

I suspect that when Mitt Romney made his remark about the 47% of Americans who don’t pay income tax and won’t take personal responsibility, he was thinking about the mythical welfare queen staying at home collecting government benefits, although you’d think that a numbers guy would realize that slackers on the dole could only be a fraction of the giant swath of America that he’d dismissed.  As many  have pointed out, those who don’t pay income tax include most retirees who rely primarily on Social Security and a large group of working age people who pay significant Social Security and Medicare payroll taxes (as well as state and local taxes).

It also includes more than half a million farmers, who would seem to epitomize hard work and personal responsibility.  (Yes, farmers receive various subsidies, but those are concentrated on a handful of crops according to Brian Riedl of the Heritage Institution.  Two-thirds of agricultural output, including fruits, vegetables, livestock, and poultry “receive nearly nothing.”)

All told, based on data from 2007 income tax returns, 563,000 tax returns reporting farm income owed no income tax after credits.  That is 28% of such returns.  It is probably an underestimate because it excludes farmers whose incomes are so low that they don’t have to file a tax return.  (The 47% figure includes households who do not file tax returns.)

How do so many farmers avoid income tax?  In part, it is because farming qualifies for some special tax treatment.  The Joint Committee on Taxationlists seven agricultural tax expenditures, but they are comparatively small, totaling just $2.6 billion over five years.  Small businesses also qualify for various tax breaks, such as the ability to immediately deduct many equipment purchases.  (Larger enterprises must spread the deductions over several years.)  But my guess is that most of the farmers who escape income tax do it because they just don’t earn that much money.  Despite working really hard.

My guess is that Governor Romney is aware of this.  The picture above shows him talking to a farmer in Iowa and I assume that he has spoken with others.  I hope he will think about those farmers when he addresses the question of the 47% on Wednesday night.

The best response would be, “I’m sorry.  I was wrong.  I know that a lot of Americans are working really hard, doing the best for their families.  I don’t believe that the big problem in this country is that multi-millionaires like me are over-taxed and that hard-working middle-income families pay too little.  The big problem is that the benefits of hard work have been increasingly concentrated at the top while earnings of lower- and middle-income workers have been stagnant for decades.  I hope that my policies would help rectify that gross inequity, but until they do, I certainly don’t plan to add to the challenges facing the 47% by raising their taxes.”

That would be a flip-flop I could believe in.

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PS, My friend Lauren pointed out that the farmer in the picture is probably a millionaire.  Yeah, probably.  Mitt really does need to get out of the bubble.

Thank you, Mitt Romney, for making us care about capital gains taxes

Back in 1999, I produced a chart showing the relationship between capital gains tax rates and economic growth in my book, The Labyrinth of Capital Gains Tax Policy: A Guide for the Perplexed (p. 81). Some economists had made miraculous claims for the effects of lower tax rates on the economy, which I argued should be apparent in time series data.  The correlation between the two time series was basically zero.  I've updated this chart periodically (for example, here), but it never got much attention until I included it in my congressional testimony last week.  In the last two days, columnists at the Washington Post and New York Times have cited the chart and my testimony.

My wife, Missie, asked why there's been such a surge of interest.  I think it's Mitt Romney's 14 percent effective tax rate, which comes largely from the light taxation of capital gains and dividends.  So thanks, Mitt Romney, for getting Americans to care about the way we tax capital gains.

Here's the press coverage (aka shameless self-promotion):

Ruth Marcus, “Romney’s tax plan,by the numbers” (Washington Post, 9/26)

Leonard Burman of Syracuse University’s Maxwell School looked at capital-gains rates over six decades and found no correlation with economic growth. Look at his graph and you’ll see: The two lines — capital-gains rates and growth — bear no relation to each other.

Burman tried adjusting for time lags, of up to five years, and looking at moving averages of tax rates and growth. Still no correlation. “There is no apparent relationship,” Burman told the Senate Finance Committee last week. “Cutting capital gains taxes will not turbocharge the economy, and raising them would not usher in a depression.”

Joe Nocera, “Romney and theForbes 400” (New York Times, 9/25)

In 2009, according to recent Congressional testimony by Leonard E. Burman, a professor at Syracuse University, the 400 highest-income taxpayers reaped an astounding 16 percent of all capital gains.

…

In the printed copy of his Congressional testimony, Burman has a chart that plots the ups and downs of the economy since the 1950s with changes in the capital gains rate. There is no correlation between the two. The idea that a lower capital gains rate spurs economic growth is one of the enduring myths of conservative thought.

Ezra Klein, “The case for raising capital gains tax rates” (Washington Post (Wonkblog), 9/25)

Tax expert Len Burman has graphed capital gains rates and economic growth and found no relationship at all.  Burman says he also “tried lags up to five years and using moving averages, but there is never a larger or statistically significant relationship.” 

What he is sure of is that a very low capital gains rate incentivizes very complex tax avoidance. “Since ordinary income is taxed at rates up to 35 percent while long-term capital gains are taxed at a maximum rate of 15 percent, there is a 20 percent reward for every dollar that can be transformed from high-tax compensation, say, to low tax capital gains.”

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Mitt Romney's Self-Imposed Buffett (Lite) Rule and Other Observations

Governor Romney’s release of his final 2011 tax return and an affidavit from his accountant that he’d really paid tax in prior years provoked a feeding frenzy from the press and the blogosphere, despite the fact that there was almost no news.  His final return was not much different from the unfiled version posted earlier, except for this:

The Romneys voluntarily limited their deduction of charitable contributions to conform to the Governor’s statement in August, based upon the January estimate of income, that he paid at least 13% in income taxes in each of the last 10 years.  (Source:  FAQ on MittRomney.Com)

I find that part interesting.  Gov. Romney voluntarily imposed a kind of Buffett Rule on himself.  Recall that the Buffett Rule, as stated by President Obama, was the principle that millionaires should not pay lower tax rates than their secretaries.  This was codified in the Senate as a minimum effective tax rate of 30%.

Gov. Romney has apparently decided that the minimum tax should be 13%, so I guess both parties have agreed on the principle and are bickering about the rate.  (Or, perhaps, Gov. Romney misheard “thirty” as “thirteen.” Romney’sphysician’s letter, also released yesterday, makes no mention of hearing loss, although the doctor does seem confident that Gov. Romney will be the “next president of the United States.”)

Josh Barro has pointed out that the Governor can file an amended return to claim the unused charitable deductions, so he views the voluntary tax reduction as a kind of campaign donation–and one that will be paid back if the candidate loses and people lose interest in his tax returns and campaign promises.

Jacob Weisberg at Slate argued that Romney’s Buffett-Lite Rule violates another campaign promise:

“I don’t pay more than are legally due and frankly if I had paid more than are legally due I don’t think I’d be qualified to become president. I’d think people would want me to follow the law and pay only what the tax code requires.”  [emphasis added]

So, earlier in the week, the candidate writes off half of voters and a big chunk of his base.  Yesterday, he did something that he had earlier said would disqualify him for the presidency.  Do you think that, perhaps subconsciously, the Governor is deliberately trying to undermine his candidacy?  (The physician’s letter also did not comment on Romney’s mental health.)

But, if I may digress into substance for a moment, there is one point that I think most reporters have missed about Mitt Romney’s tax returns:  he pays much, much less than a 15% rate on his capital gains.   Most observers have noted that the 13 or 14% rate that the Governor pays reflects the fact that most of his income comes in the form of capital gains and dividends, both of which are taxed at a maximum rate of 15%.

However, Romney was able to avoid capital gains tax entirely on nearly $1 million of assets simply by donating them to charity.  He reported $920,573 of noncash donations to his foundation, all of which were shares of appreciated stock.  If the Romneys had sold the shares, they would have had to pay tax on any accumulated capital gain. By donating the shares directly to charity, they saved potentially tens of thousands of dollars (depending on how much the assets had appreciated in value).  And they got the charitable deduction on top of that.

An even bigger capital gains loophole is what columnist Michael Kinsley has called the “Angel of Death loophole.”  If you hold onto appreciated assets until you die, the capital gains are never taxed.  Your heirs get to pretend that they bought the asset on the day you died.  Heirs will avoid $44 billion in tax through the Angel of Death loophole in FY 2013 according to Congress’s Joint Committee on Taxation.  Presumably, the Romneys are planning to take advantage of it too.

All of these techniques are perfectly legal.  And they are one reason why wealthy taxpayers can pay much lower effective tax rates on their capital gains than the advertised rates.  And the very light taxation of capital gains is more than an issue of equity.  It surely results in much economically unproductive tax sheltering activity.

I discussed the economic issues surrounding the taxation of capital gains at ajoint hearing of the House Ways and Means and Senate Finance Committeeson Thursday.  A video link is on C-Span.

Once again, I’m grateful to Gov. Romney for creating a teachable moment on an important subject.

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Even if Governor Romney's Tax Plan Could be Made to Add Up, It Wouldn't Make Any Sense

Harvard Professor Martin Feldstein weighed in on the mathematical feasibility of Governor Romney’s tax plan in today’s Wall Street Journal. His bottom line: using his assumptions and his preferred dataset, the plan could raise revenue without raising taxes on the middle class.

Mitt Romney’s plan to cut taxes and offset the resulting revenue loss by limiting tax breaks has been attacked as “mathematically impossible.” He would reduce all individual income-tax rates by 20%, eliminate the Alternative Minimum Tax and the estate tax, and limit tax deductions and loopholes that allow high-income taxpayers to reduce their tax payments. All this, say critics, would require a large tax increase on the middle-class to avoid raising the deficit.

Careful analysis shows this is not the case.

Professor Feldstein’s critique basically shows that if you use different assumptions and data, you can come up with a different conclusion–possibly not the most earth-shattering finding ever.  There are substantial differences between Marty Felstein’s analysis and the earlier study that he critiques (and possibly an oversight or two).

Marty based his conclusions on published IRS tabulations of data for 2009.  The original Tax Policy Center study was based on projections for the year 2015.  Marty’s calculations were at the aggregate level whereas TPC’s were based on a tax calculator that uses data from 100,000-plus individual income tax returns. Marty does not consider the cost of repealing the high-income surtaxes enacted as part of the Affordable Care Act whereas TPC assumes that is part of the baseline.  Possibly the most significant difference is that Marty seems to have significantly narrowed the definition of middle class.  He assumes that the loophole closers would apply to people with incomes over $100,000, whereas TPC assumes that taxpayers with incomes below $200,000 would be held harmless in Romney’s plan.

Under those assumptions, Marty estimates that the Romney tax cut would have cost about $186 billion in 2009 (after accounting for taxpayers’ reporting more income when their tax rates are cut). Taxpayers with incomes over $100,000 reported itemized deductions totaling $636 billion (including the deduction for charitable contributions, which the GOP platform pledges to preserve).  Assuming an average tax rate of 30 percent (which is too high given that the Romney plan would cut top rates to 28 percent), this generates “[e]xtra revenue of $191 billion—more than enough to offset the revenue losses from the individual income tax cuts proposed by Gov. Romney.”  (Presumably, Professor Feldstein is also assuming that the standard deduction would no longer be available to people with incomes over $100,000; otherwise, the tax savings would only be the excess of itemized deductions over the standard deduction.)

I obviously have some issues with Marty’s assumptions, but will let them go for a moment.  Suppose you took seriously that this is the “tax reform” that Mitt Romney has in mind:  Your income reaches $100,000 and your itemized deductions go to zero.

I can’t imagine that Professor Feldstein, Mitt Romney, or anyone who cares about economic incentives would support such a thing. It would produce a huge toll gate on entry into the upper middle class.  Say you had $15,000 of itemized deductions and income of $99,000.  If you got a $10,000 raise, your gross income would increase by that amount, but your taxable income (gross income minus deductions) would rise by $25,000.  If you are in the 25 percent tax bracket, your effective tax rate would be 62.5 percent (2.5 times 25 percent)!

For people with very high incomes, the rise in marginal tax rates would be smaller, but to the extent that itemized deductions rise with income, the loss of those itemized deductions means that the cut in marginal effective tax rates on high income people will be less than the cut in statutory rates.  That is, taxpayers currently in the 35-percent bracket don’t face an effective rate of 35 percent because they can shelter some of each dollar of additional income with additional itemized deductions.  (This is why the TPC was skeptical of claims that Gov. Romney’s plan would produce significant behavioral responses.)

So even if it were “mathematically possible” for Romney’s plan to be revenue neutral (which it’s not), such a plan would make no sense as policy.

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Note to Governor Romney: Growth by Itself is not an Anti-Poverty Program

Today is not only the start of the GOP Convention, but the start of classes at Syracuse University, where I teach a class on Social Welfare Policy to MPA students.  This semester, we’ll obviously be talking about the presidential candidates’ positions on issues such as welfare and poverty.  I looked for the Romney campaign’s position statement, though, and came up empty.  Theirissues page lists 23 topics, but those two apparently do not merit inclusion.

When asked, Mitt Romney summarized his policy this way: “I’m not concerned about the very poor. We have a safety net there. If it needs repair, I’ll fix it.” But the Ryan budget plan would slash the social safety net.  According to the Center on Budget and Policy Priorities, almost two-thirds of Mr. Ryan’s spending cuts come from programs that help lower-income Americans.  You can quibble about the details of CBPP’s analysis, but there’s little evidence to support Governor Romney’s pledge to repair the safety net if necessary.

The cornerstone of the Romney program is that his policies will fuel much more economic growth.  There are many reasons to doubt Romney’s growth projections, but even if they materialized, would they trickle down to help the poor?

The first reading for my class is from a book called Changing Poverty, Changing Policies, edited by Maria Cancian and Sheldon Danziger.  They address this issue at the outset:

It is not surprising that the severe economic downturn that began in late 2007 reduced employment and earnings and raised the official poverty rate. What many readers may find surprising, however, is that even during the long economic expansions of the 1980s and 1990s the official poverty rate remained higher than it was in 1973. … Even though gross domestic product (GDP) per capita has grown substantially since the early 1970s, the antipoverty effects of of this growth were substantially lower than they were in the quarter-century that followed the end of World War II.  Economic growth is now necessary, but not sufficient, to significantly reduce poverty. [p. 1, emphasis added]

In other words, governor, growth by itself is not an anti-poverty program.

There are smart thoughtful conservatives who are concerned about the very poor and have written volumes on the subject. You might ask them to help you craft a policy proposal, or at least a set of principles (which is what theWhite House website offers). My students will be debating different approaches.  You and President Obama should too.

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Paul Ryan's Tax Philosophy Explained

In a new paper, USC law professor, Ed Kleinbard, has pored through Paul Ryan’s “Roadmap for America’s Future,” including  100 pages of legislative language, to gain insights into the VP candidate’s tax philosophy.  The Roadmap would represent a radical change in our tax system–massively cutting taxes on people like Governor Romney because capital gains and dividends would be entirely exempt from tax, and raising taxes on middle-income households because there’s a new cash flow tax on businesses (basically, a VAT) that would translate into higher prices or lower wages.

Despite all the detail in the Ryan plan, it shares one feature with the Romney campaign proposal in that it doesn’t explain how it would offset the cost of the large tax cuts specified.  When Ryan made the proposal, he instructed the CBO to assume that the plan would keep tax revenues at 19 percent of GDP (slightly higher than the historical average) even though the pieces specified would fall far short.  Also, as Kleinbard notes, Ryan proposed the plan when he was a member of the minority and it had no chance at all of getting a hearing, much less being enacted.  It didn’t matter back then that it was politically impossible.

Nonetheless, I found Kleinbard’s analysis fascinating and worth a read.  Here is his summary:

The purest articulation of Paul Ryan’s fiscal belief system is his 2010 Roadmap for America’s Future. The tax provisions of this extensive proposal would convert the current personal and corporate income taxes into two consumption taxes, and repeal the gift and estate tax.

This report explains how the Roadmap, like Herman Cain’s 9-9-9 Plan, would operate in practice like a large new payroll tax. The Roadmap would directly immunize the highest labor income earners from this tax through a large reduction in the top rate of the Roadmap’s labor earnings tax, compared with current law or policy. Unlike the 9-9-9 Plan the Roadmap further would largely immunize “old” capital from the efficient (if arguably unfair) imposition of consumption tax when that capital was consumed, by providing a write-off of existing depreciable basis. And finally the Roadmap would reduce the tax burdens on the most affluent capital owners further by eliminating the gift and estate tax.

For these reasons, it is not surprising that the Roadmap contemplates an extraordinarily large redistribution of tax burdens from the affluent to middle-class and lower income Americans. For middle-class families, tax burdens would increase on the order of 50 percent. At the same time, the Roadmap’s reprioritization of government spending also would be regressive in its impact. Proponents of the Roadmap or plans like it must explain how any projected increase in economic growth will compensate the majority of Americans for shouldering more tax burdens while receiving smaller government benefits.

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Conservatives Suggest we Should Emulate Canada

At least some conservatives have been suggesting that we should look north of the border for a model of fiscal down-sizing.  This is fascinating given that Canada’s spending has always been greater than ours as a share of GDP and they offer a much more expansive social safety net–most notably, “socialized medicine” available to all Canadians with no out-of-pocket payment responsibilities by patients.

For example, the American Enterprise Institute is sponsoring an event on September 18 titled “Fiscal sanity and political success: Canada proves you can have it all.” Here is their summary:

In the 1990s, Canada suffered from the same economic malaise that plagues the U.S. today: slow economic growth, heavy government spending and a rising national debt. Canada’s remarkable turnaround relied relatively little on raising taxes; instead, federal program spending was cut by nearly 10 percent over a two-year period to restore its budget to balance. Its federal government also devolved greater responsibility to provincial governments, leading to a decade of strong growth in employment, gross domestic product and investments. Despite the political challenges of reform, the governments responsible were consistently re-elected both federally and provincially.

To say that the causes of Canada’s debt problems in the 1990s and ours now have similar origins is at best disingenuous.  In the mid-1990s, the world economy was booming, whereas the recent run-up in debt has come during a massive economic recession.  Canada’s deficits reflected simple political failure to face fiscal constraints whereas our current deficits are largely the consequence of what most economists would view as a necessary response to the recession.  Indeed, we were reducing deficits in the 1990s –through a mixture of spending cuts, higher taxes, and the economic boom–at the same time that Canada was adopting their vaunted fiscal adjustments.

And Canada’s spending at all levels of government in the early 1990s was around 50 percent of GDP.  Ours was around 36 percent before the Great Recession.  (I’m citing OECD numbers, which are somewhat higher than the official US statistics, so as to allow comparison between the two countries. Kathy Ruffing of Center on Budget and Policy Priorities cogently explicates the differences here.)

You may be surprised to know that Canada’s spending, which some conservatives are now citing as a model of government efficiency, is still higher than spending in the US (measured as a share of GDP) and likely to remain so for the foreseeable future. This raises the question of whether conservatives would be happier with the size of our public sector if we’d only started with a much higher base level of spending.

The idea that devolving spending to lower levels of government (provinces in Canada, state and local governments in the US) represents fiscal constraint also strikes me as very odd, although it is clearly part of the US conservatives’ plan to fix our budget problems. Paul Ryan’s budget would shift a large and growing share of government spending onto the states over time–by block-granting Medicaid, for example. There are arguments for and against devolution (the main argument for is that lower levels of government may be more responsive to constituents; the main argument against is that states can’t support an adequate social safety net because high-income taxpayers will flee to lower-tax/lower-service jurisdictions), but the mere act of shifting spending from federal to lower levels of government does not make government smaller.

One way that Canada does appear to be the model of efficiency is in the provision of healthcare.  Canada spends about 11 percent of GDP on healthcare whereas US spending is about 18 percent for far less than universal coverage. (Source: Worldbank)  Although I’m not aware of conservative endorsement for the Canadian version of socialized medicine as a cure for our fiscal woes, GOP presidential candidate Mitt Romney did seem to endorse the Israeli model during his recent visit there.

When our health care costs are completely out of control. Do you realize what health care spending is as a percentage of the GDP in Israel? 8 percent. You spend 8 percent of GDP on health care. And you’re a pretty healthy nation. We spend 18 percent of our GDP on health care. 10 percentage points more. That gap, that 10 percent cost, let me compare that with the size of our military. Our military budget is 4 percent. Our gap with Israel is 10 points of GDP. We have to find ways, not just to provide health care to more people, but to find ways to finally manage our health care costs.

Maybe the divide between conservatives and liberals is smaller than we imagine.

(I know this isn’t true, but sometimes there are these tantalizing hints of reasonableness before the orthodoxy vigilantes intervene.)

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TPC Removes the Veil from Romney Tax Plan: The Governor is not Amused

The Tax Policy Center (TPC) caused a kerfuffle on Wednesday when they released a studythat showed that the mostly unspecified parts of Mitt Romney’s tax cut proposals would amount to a giant tax increase on low- and middle-income households. The problem is that Romney has promised large tax cuts that would mostly accrue to the well off and also that the plan would close enough unspecified loopholes so that it doesn’t increase the deficit. However, the only tax breaks and loopholes large enough to offset the cost of the high-end tax cuts disproportionately benefit the middle class. Thus, their taxes would go up on balance.

The Romney campaign responded by calling the TPC “biased” and the study “a joke.”

As Yogi Berra would say, it’s déjà vu all over again. In 2008 (when I directed the TPC), we published a study which, among other things, concluded that Senator McCain’s proposal to allow taxpayers to opt for an alternative flat-rate tax system would add trillions to the deficit and convey a huge tax cut to millionaires. The McCain campaign insisted that the optional alternative tax would be revenue neutral, which could only be true if millions of people would opt for the alternative even though they would pay more tax. That defies logic, but logic has never been a hallmark of political campaigns.

In 2008, both candidates complained that TPC had made up stuff to fill in the giant gaps in their tax plans—all clearly labeled as our assumptions, but still not the actual plans. (Both campaigns, however, were also willing to fill in many, although not all, of the missing pieces when we pointed them out). The critique was that we made assumptions that were not part of the campaign proposals, but the campaigns would not tell us what assumptions we should have made. It’s kind of a Catch-22. Both sides criticized us for making unwarranted assumptions, but the campaigns would not tell us what the actual policies were beyond the unrevealing sound bites.

It is happening again. Governor Romney has done what politicians like to do, which is talk about how he plans to cut our taxes. His plan would cut tax rates by 20 percent across the board (the top rate would fall from 35 to 28 percent and the bottom bracket from 10 to 8 percent); he’d repeal both the AMT and the estate tax; and he’d exempt investment income from tax for couples making under $200,000 (singles under $100,000).

So far, it just sounds like President Bush’s tax plan on steroids, but unlike President Bush, Mr. Romney promises that his plan would not increase the deficit or make the tax system less progressive. He says that he would close unspecified loopholes to make up the lost revenue. He also proposes to eliminate the Obama tax cuts, which disproportionately help those with low incomes, but insists that low-income people won’t see an increase in tax burdens.

The Tax Policy Center on Wednesday basically said that the plan doesn’t add up. TPC tried hard to find loophole closers that could make up the revenue lost from Romney’s plan while preserving the current distribution of tax burdens. They assumed that tax breaks such as the deductions for mortgage interest, charitable contributions, and state and local taxes, and the tax exclusion for employer sponsored health insurance would be entirely eliminated for high-income people. This would be difficult or impossible to implement, but the study’s authors were trying to craft the best possible scenario for the Romney plan. Nonetheless, high-income taxpayers still got a substantial net tax cut under the plan, meaning that tax breaks would also have to be trimmed for those with lower incomes. TPC also gave Romney the benefit of the doubt by assuming (unrealistically) that the plan would significantly boost economic growth and thus produce more tax revenues, but, still, there were not enough high-end loophole closers to offset the super-sized tax cuts the plan would bestow on the rich. Thus, revenue neutrality would require tax increases on the middle- and lower-income groups. And, some really popular tax breaks—such as the mortgage interest deduction and the tax break on employer-sponsored health insurance—would have to be curtailed or eliminated. There are good policy reasons to cut those tax breaks, but those cuts are politically impossible.

There is, in fact, one giant tax break that could be curtailed to offset the effect of the rate cuts: the lower tax rates on capital gains and dividends. (They are the main reason Mr. Romney was able to pay an average tax rate of 13.9 percent in 2010.) Taxing gains and dividends the same as ordinary income, which Ronald Reagan’s Tax Reform Act of 1986 did and two bipartisan debt reduction plans proposed, might have provided the magic bullet to pay for the rate cuts without cutting overall taxes on the rich, but Romney has ruled that out. Indeed, his plan would set the tax rate on investment income to zero for those with modest incomes.

Aside from listing some tax breaks he would not touch, Mr. Romney is mum on which large tax expenditures he would like to eliminate to make his plan work. An advisor said that “it would be up to Congress to help fill in the blanks.”

Well, TPC has given them a head start on the job, and it’s just not possible to do it in a way that meets all of Mr. Romney’s promises. Either the plan will raise taxes substantially on low- and middle-income households or it would balloon the deficit.

TPC’s blogger Howard Gleckman explains that TPC’s analysis really just shows something not too surprising—that Mr. Romney will not keep all of his campaign promises.

Thus, the right question to ask Romney is not whether he wants to raise taxes on the middle-class. The right question to ask is which of his campaign promises he will abandon.

Romney won’t, of course, answer that question.

But his campaign’s attack on the TPC’s credibility is unlikely to stick either. Doug Holtz-Eakin (John McCain’s policy director in 2008) chose Donald Marron, TPC’s director, as his deputy at the CBO and George W. Bush appointed him to the Council of Economic Advisers. Donald is also off-the-charts smart and scrupulously honest, characteristics he shares with the study’s authors and the other TPC scholars.

As David Firestone of the New York Times pointed out:

The Tax Policy Center, if anything, comprises a gang of raging moderates from both parties who have infuriated ideologues for years by simply telling the truth about the tax system.

Good work, TPC.

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Gov. Romney: Just Release the Tax Returns

Mitt Romney is right that the Democrats’ attack on him for not releasing his tax returns is a diversion from real policy issues that should determine who the next president is, but he’s not going to win this battle and it’s painful to watch it play out in slow motion.

I don’t know why Gov. Romney released fewer tax returns than previous candidates. Possibly he believes that he’s entitled to something like the privacy of ordinary citizens, whose tax returns are completely confidential.  But that would be incredibly naive.  Candidates’ lives become an open book when they decide to run for president and anyone not willing to tolerate that shouldn’t run.

Possibly, he has something to hide. The White House is peddling that line. Washington Post blogger Greg Sargent talked to tax lawyers and economists who said it’s possible that he could have sheltered much of his income from tax using offshore tax havens or other techniques.  University of Virginia law professor George Yin said that you’d expect somebody with a lot of wealth to hire good advisors to minimize taxes, all presumably in compliance with the law. Would it shock and appall the American public to see how that’s done?

It’s remotely possible that Governor Romney avoided US income tax entirely in some years. The IRS periodically looks at the returns of high-income filers who pay no income tax. Some returns are nontaxable in the US, but have foreign income that is taxed abroad at rates at least as high as would apply in the US.  That’s unlikely to be Gov. Romney’s situation.

Among tax returns with no net tax liability anywhere, the most common tax shelter is tax-exempt bonds.  That was the prime factor explaining tax avoidance in 2009 according to the IRS. (See chart.)  But it’s hard to imagine that the former CEO of Bain Capital would be happy with returns of 3 or 4 percent, even if they were tax free, and extremely unlikely that all the various sources of income on the governor’s 2011 return would have been absent in prior years.  Although much has been made of Romney’s lightly taxed capital gains, he had $10 million of income from interest, dividends, and partnerships.

Source: Internal Revenue Service,."High-Income Tax Returns for 2009," SOI Bulletin, Spring 2012. (Public Domain)

Taxpayers can reduce tax liability through charitable contributions, but they can’t eliminate it.  If Romney avoided income tax altogether, my guess is that his partnership holdings generated large losses.  That was the most important factor on 5.7% of nontaxable returns in 2009.

There might be a hint on the governor’s 2010 return.  In that year, the Romneys reported a $280,000 partnership loss.  In 2011, the partnerships produced income of over $2 million.  Was this the end of a process where the partnerships were converted from tax shelters into income generators–possibly in anticipation of the scrutiny that would accompany the Romney tax returns when he became a candidate? Who knows?

Of course, there’s also the $10 million of capital gains on the Romneys’ 2011 return ($5 million in 2010). It is fairly easy to avoid paying tax on capital gains if you are wealthy.  Don’t sell assets with gains.  When you have to sell assets with gains, also sell some with losses so your net gain is close to zero. It’s possible that the capital gains that played so prominently on the Romneys’ released returns are largely absent in earlier years.

It’s also possible–even likely–that seeing the returns would not tell us that much.  If much of the income is parked in offshore entities, it might not be reported at all on US income tax returns until those entities pay a dividend.

But assuming that whatever the Romneys did was legal, it’s hard to imagine that his tax returns could be more damning than the speculation surrounding their suppression.  Mr. Romney is rich and he doesn’t pay much tax.  We already know that.

Is it possible that the earlier returns would reveal some real chicanery? That seems extremely unlikely. As Romney supporter Michael Gersonpointed out, “Romney — though he has his weaknesses as a candidate — does not fit the part of a sleazy businessman or a Nixonian liar.”

When your supporters are saying that you’re not a Nixonian liar (great bumper sticker), it is time to change the narrative.  Release the returns and let’s move on to the real debate.

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