In this paper we examine the tradeoffs between rates, tax expenditures, and the progressivity of the tax schedules that are inherent in revenue-neutral tax returns. We show that plans that advance steeply lower marginal tax rate structures would require deep cuts in tax expenditures to offset the revenue losses arising from low rates. Because many of the largest tax expenditures benefit middle- and lower-income households, deep reductions tax expenditures can alter the distribution of the tax burden. To illustrate these tradeoffs, we examine as an example a set of tax rate reductions specified in Governor Romney’s tax plan. We show that given the proposed tax rates and proscription against reducing tax expenditures aimed at saving and investment, cutting tax expenditures will result in a net tax cut for high-income taxpayers and a net tax increase for lower- and/or middle-income taxpayers—even if individual income tax expenditures could be eliminated in a way designed to make the resulting tax system as progressive as possible.
The Romney campaign has disputed this conclusion. Both Romney and Ryan have pointed to "six studies" which support the Romney tax plan. A blog posting on the Romney web site states that "six independent studies have proven there are sufficient upper-income expenditures to lower individual tax rates, protect the middle class, and make the tax code more pro-growth".
There has also been a great deal written outside the Romney campaign on these six studies. Two examples are a Politifact article titled "Ryan says six studies say the math works in Romney tax plan" and an article titled "Wonkblog’s comprehensive guide to the debate over Romney’s tax plan".
Because of the large number of conflicting articles on the Tax Policy Center study and the six studies that countered it, it seems that a first step was to organize those articles in one place. I've posted links to the studies and related articles at this web page. It contains the following:
- The original Tax Policy Center article and some follow-up and earlier articles.
- The "six independent studies" critiquing the Tax Policy Center article, along with articles critiquing specific studies.
- Other articles favorable of Romney Tax Plan.
- Articles critiquing the "six independent studies".
- Other articles critical of Romney Tax Plan.
- IRS Tax Data.
In any case, I was able to verify most of Feldstein's numbers. The following table shows those numbers:
Projected Revenue Gain/Loss from Romney Tax Plan (billions of dollars) 2009 IRS Data Feldstein ======================= =============== Adjusted Gross Income --> All 100K+ 200K+ All 100K+ ========================= ======= ======= ======= ======= ======= Income tax before credits 976 682 449 953 Dividends & capital gains 49* 49* ------------------------- ------- ------- ------- ------- Tax affected by rate cut 927 904 Revenue loss of 20% cut 185 181 Alternative minimum tax 23 23 Investing tax cut 15* 15* ------------------------- ------- ------- ------- ------- Static revenue loss 223 219 Dynamic revenue loss 190* 186* ========================= ======= ======= ======= ======= ======= Home mortgage interest 421 199 67 State and local taxes 252 184 113 Real estate taxes 168 88 36 Contributions deduction 158 99 59 Other itemized deductions 206 67 30 ------------------------- ------- ------- ------- Total itemized deductions 1,204 637 305 636 Revenue gain at 30% 191 91 191 Revenue gain at 25%|27% 159 82 159 ================================================================= Note: following are estimates of revenue loss not included above: ----------------------------------------------------------------- Estate tax elimination 21* Phase in of deduction loss 15* ================================================================= * estimated by Feldstein (else 2009 IRS data) Sources: 2009 IRS Tax Data, Table 1.4, Sources of Income, Adjustments, and Tax Items 2009 IRS Tax Data, Table 2.1, Sources of Income, Adjustments, Itemized Deductions Martin Feldstein's Wall Street Journal article, August 28, 2012 Martin Feldstein's blog post, September 02, 2012In Feldstein's Wall Street Journal article, he states the following:
The key question raised by the Romney plan's critics is whether this revenue loss can be offset by broadening the tax base of high-income individuals. It is impossible to calculate the exact effects of the future reforms since Gov. Romney hasn't specified what he would do. But refuting the Tax Policy Center's assertions doesn't require that. It only requires knowing if enough revenue could be raised from high-income taxpayers to cover the $186 billion cost.
A little later on, he states:
And what do we get when we apply a 30% marginal tax rate to the $636 billion in itemized deductions? Extra revenue of $191 billion—more than enough to offset the revenue losses from the individual income tax cuts proposed by Gov. Romney.
So Feldstein's basic argument is that the revenue loss of $186 billion shown in the second to the rightmost column above is more than offset by the $191 billion revenue gain shown in the rightmost column. The first step in testing this contention is to verify Feldstein's numbers. I could not verify the numbers followed by asterisks in the IRS data. However, those numbers have a relatively small effect on the final numbers.
According the Feldstein, the "$49 billion was from taxing dividends and capital gains at reduced rates that would not be subject to further reductions". This reduces the estimated revenue loss by $10 billion. The $15 billion is from "eliminating the tax on interest, dividends and capital gains for married couples with incomes below $200,000, and for single taxpayers with incomes below $100,000" and increases the estimated revenue loss by that amount. Finally, the $33 billion reduction in the estimated revenue loss from $219 billion to $186 billion is due to Feldstein's assertion that "past experience shows that taxpayers do respond to lower marginal tax rates by acting in ways that increase their taxable incomes". Regarding this assertion Washington Post columnist Ezra Klein says the following:
Feldstein assumes fairly large, and very positive, growth and behavioral effects from the tax cuts. But he doesn’t assume negative effects. Most models — including, as I understand it, TPC’s — assume that as you cut deductions, taxpayers who were managing their finances to take advantage of those deductions stop doing that. That makes the deductions effectively worth less money, and makes it harder to pay for tax cuts.
In any case, Feldstein's other numbers closely match the IRS numbers except for one. He gives the "income-tax revenue in 2009 before all tax credits" as $953 billion. The IRS data gives this as $976 billion for all returns and $950 billion for all taxable returns. However, this only has an effect of $4 billion on the projected revenue loss. Even with this, the projected revenue loss of $190 billion is just covered by the projected revenue gain from base-broadening of $191 billion.
There are some issues with this projected revenue gain of $191 billion, however. First of all, Feldstein mentions in his follow-up blog post that critics have pointed out that the "30 percent marginal tax rate is too high for these taxpayers because of the 20% Romney rate reduction". He then states that "using a 25% marginal tax rate instead of 30% would reduce the revenue from eliminating deductions by 5% of $636 billion or $32 billion". This cuts the projected revenue gain to $159 billion.
Next, Feldstein's figures are based on the idea of eliminating all deductions for taxpayers whose adjusted gross income (AGI) is $100,000 or more. But when asked about the $100,000 limit in a September 14th interview with George Stephanopoulos, Romney said the following:
No, middle income is $200,000 to $250,000 and less. So number one, don’t reduce– or excuse me, don’t raise taxes on middle-income people, lower them.
Hence, it's unlikely that Romney would agree to eliminate all deductions for someone making between $100,000 and $200,000 per year. The table shows that eliminating all deductions for just those with incomes over $200,000 only provides about $82 billion in increased revenue. This is just 43 percent of the projected revenue loss of $190 billion. Hence, it would seem necessary that deductions would need to be reduced severely for workers making between $100,000 and $200,000 per year. In addition, the table above shows the key deductions that would need to be severely limited. They would be chiefly be the deductions for home mortgage interest, state and local taxes, real estate taxes, and charitable contributions.
Following are five points for Romney's tax plan as given on his web site:
- Make permanent, across-the-board 20 percent cut in marginal rates
- Maintain current tax rates on interest, dividends, and capital gains
- Eliminate taxes for taxpayers with AGI below $200,000 on interest, dividends, and capital gains
- Eliminate the Death Tax
- Repeal the Alternative Minimum Tax (AMT)
Note: There is a discussion of this post at this link.