StanCollender'sCapitalGainsandGames Washington, Wall Street and Everything in Between



Romney Tax Reform: Reading Between The Blank Lines

05 Oct 2012
Posted by Clint Stretch
Like Governor Romney, I have raised a number of kids.  One of the things I learned to do with them was to listen to the silence.  When it got too quiet upstairs, when a good friend’s name vanished from conversation, or when the cheery reports about a wonderful teacher stopped, I knew something important had happened, and it was time to tune in. 
 
My liberal friends are frustrated that Governor Romney will not identify the tax benefits he plans to repeal in order to lower individual tax rates by 20 percent.  I am not frustrated.  In the debate, Governor Romney gave us some solid guideposts to understanding what details are in the silence.  The specifics necessary to create an economic model might be missing, but the principles and vision he outlined give us substantial clues – fuel enough to feed the exercise of common sense.

Governor Romney said that he is not going to reduce overall revenue, but instead is cutting rates and then taking away tax preferences to offset the lost revenue from rate reduction.  He also said he will not “reduce the share of taxes paid by high-income people” Common sense would dictate, then, that there will be winners and losers in the Romney plan.  
 
Let’s look first at the winners.  Governor Romney specifically noted that one of the main purposes of his reform is to cut taxes on small business owners who pay tax at ordinary rates, and that he will “lower taxes on middle-income families.” So, we know that small business owners and middle class families are going to be winners.  Can we begin to divine who are the losers might be? I think we can at least see the choices.
 
Let’s do some common sense math with two groups of taxpayers working from 2009 IRS tax return data, assuming Governor Romney’s promise that his tax plan will be revenue neutral.  First the rich: the top two-tenths of one percent of taxpayers, who had adjusted gross income of over $1 million in 2009.
 
Together, they reported about $500 billion of ordinary income, $200 billion of capital gains and qualified dividend income, and about $100 billion in itemized deductions.  Lowering the tax on $500 billion of ordinary income by 7 percentage points (20 percent of the 35 percent top rate) would cost $35 billion. Repealing all the itemized deductions of these taxpayers would raise only $28 billion (at the Romney tax rate of 28 percent), still leaving a deficit of $7 billion. My numbers are quick and dirty, but clearly there is not much room to allow exceptions to repealing itemized deductions.  There will be no room at all for exceptions if high-income taxpayers are called on to pay for a net tax cut for the middle class.
 
Other possibilities for offsetting the cost of the rate cut for these individuals would include limiting their retirement savings options and their exclusions or deductions for medical coverage.  There are only about 250,000 families earning more than $1 million.  So, adding another, say, $60,000 to the income from these families by ending retirement savings and health care benefits would raise only about $4 billion in taxes. 
 
If repealing itemized deductions cannot pay for the rate cuts and middle class relief that Governor Romney desires, the alternative would be to increase tax rates on capital gains and qualified dividends.  Like President Reagan in 1986, Mr. Romney has said he will not increase these rates.  But, when Congress turns to working out the details to fulfill this rate-reduction vision, I think investors would be foolish to assume that Congress will make life harder for charities and for state and local governments without asking investors to chip in too.  It had similar choices in 1986 and chose to increase capital gains taxes.
 
Let’s turn now to a broad swath of the middle class, those with adjusted gross incomes between $50,000 and $200,000. The difficult choices within Romney’s vision are different than with high income individuals because capital gains and dividends are such a small part of that group’s income.  That group had $2.7 trillion of taxable income in 2009.  If we assume the impact of reducing every tax rate by 20 percent is in on the same order of magnitude as reducing the effective tax rate by 20 percent, then that rate reduction would cost something in the $85 billion range. This is a dicey assumption because of graduated rates and personal exemptions, but i make a similar, but hopefully offsetting, assumption on the deduction side of the ledger.
 
Now how would the Romney plan pay for this reduction?  He has promised not to raise middle-class taxes, so some standard deduction and personal exemptions must be left in place to avoid throwing middle class families who do not now pay tax onto the rolls.  But, even without the standard deduction, repealing all of the itemized deductions claimed by taxpayers with incomes between $50,000 and $200,000 would barely raise enough to offset the rate cut benefits.  So, some amount of additional offsets would be needed. 
 
One possibility would be for higher income folks to pitch in with higher rates on capital gains.  Another would be to repeal tax credits for all taxpayers.  The largest two, the Child Credit ($19 billion) and education credits, cost $19 billion and $7 billion, respectively in 2009. Lastly, the exclusions for employer provided healthcare and retirement savings could be limited.  Limiting these two benefits could provide substantial potential revenue.  My guess is that some of all of the above would be required.
 
So, when Congress turns to working out the details of the Romney 20-percent-rate-reduction vision for the middle class, it will have to consider some combination of
  • Radically curtailing itemized deductions,
  • Increasing taxes on families with children by eliminating exemptions,
  • Eliminating incentives for education,
  • Making it harder to save for retirement,
  • Taxing on health benefits, or
  • Shifting a significant version of the tax burden to higher-income taxpayers. 
To an economist, any or all of these might be worth the sacrifice in order to achieve a lower tax rate.  But, given the reactions of the public and interest groups, a member of Congress will find the sale painful, and the sacrifice could include not just tax benefits, but also his or her political future.

When the kids were too quiet, we learned that if we listened carefully, they were actually giving us a lot more information than we thought. The same can be said of the Romney tax plan. If we listen carefully, he has actually been saying a lot about who the winners and losers will be.   

Business Income

I'm having a hard time evaluating what Romney intends to do with noncorporate business income (sole proprietorships and passthrough income). He hasn't excluded business income/deductions from the cap, at least not explicitly.

The IRS summary of sole proprietorship returns for 2009 says there were 22,660,000 tax returns with sole proprietor's income; these reported about $1.12 trillion gross receipts and $934.5 billion itemized deductions. So the mean was receipts of $52,000 and expenses, etc. of $41,000. So does a fictional mean-proprietor go from $9k taxable income to $17k taxable income? In the aggregate, starting at a 35% rate, we'd have to go down to an 18.5% rate to keep taxation of sole proprietors in the same place as it was. That won't happen, right?

The IRS 2009 information also shows differences between highly capital intensive industries like construction ($173bn receipts, $146 deductions), higher overhead industries like retail sales ($179 and $171), and then, on the other hand, professional services ($157 and $90).

Our present tax system tries to help capital intensive industries, and that may or may not be a good idea. But a per-capita limit on itemized deductions would be a real 180 degree turn. And a true, hard cap would really be a problem for people with high costs of goods sold, or expensive, depreciable machinery.

Unfortunately, I don't have time to figure out whether the numbers on the fiscal-policy side provided here include or exclude these business deductions. Maybe you can carve this income out, and still get somewhere decent.

But then, don't we already have a version of this idea? Why does everybody love the AMT so well, again?


What's the Principle?

Your back-of-the-napkin analysis is reasonable assuming one thing: the 20% rate cut is not negotiable. This makes the priorities of the tax plan:
1) 20% rate cut
2) offset by deductions to make it revenue neutral.

Alternatively, and the way Romney pitched the plan in the debate, is to prioritize this way:
1) tax reform is revenue neutral
2) Try to trade off marginal rates and deductions to get to 20% overall rate cut.

The 20% seems like a ballpark number that is not set in stone. What's most important is the idea of revenue neutral tax reform. (Romney never even mentioned the 20% number in the debate.) If the analysis comes up short, is Romney likely to support tax increases on the middle class? Or a 16% rate cut instead? I think he has made clear the latter.

The campaign has also floated deduction caps of various amounts (Romney mentioned both 25,000 and 50,000 dollars in the debate, the campaign has floated the number 17,000). What's important is the idea of a deduction cap rather than targeting individual deductions, not the amount.

In order to be more in line with the principles Romney's espoused, any analysis should be done taking revenue neutrality as a principle and then seeing how big the rate cut can be.


It's simple Math

While you wrote a nice article, this is very simple. Mr Rommey put out a plan for lower taxes. Does the simple math add up. Based on all account available, the answer is no. Plain and simple. Why couldn't you just answer this question from the start. If this is your plan show how the plan works from start to finish. But Mr Rommey can't make the plan work because of the simple math involved. Plain and Simple, you should try it in you next article.




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