Last week’s big news in campaign policy was the Tax Policy Center’s white paper by Samuel Brown, William G. Gale, and Adam Looney, arguing that it is mathematically impossible for the Romney tax plan to meet its described goals. Ezra Klein has write-ups here and here, and James Pethokoukis has a contrary analysis here. Since Romney hasn’t released his plan, Brown, Gale, and Looney cleverly put together the best case scenario and crunch the numbers — and conclude they don’t work.
Romney’s plan has three goals: It starts by lowering tax rates by 20 percent. It then seeks to keep raising the same amount of tax revnues as before by removing tax expenditures, or the variety of exemptions, deductions, or credits in the tax code that function as government spending. As the wonks would say, it wants to “lower the rates and broaden the base.” However, and this will be crucial, it excludes expenditures related to investment income and savings from these cuts. Finally, it attempts to maintain the current level of progressivity by making sure that the top one percent pays no less in taxes and everyone else pays no more.
The Tax Policy Center analysis shows that it is impossible to do all three, however. To enact the Romney plan requires cutting taxes on the top one percent — and raising them on everyone else.
In order to better understand why Romney’s aims are incompatible, we need a quick, back-of-the-envelope class and distrbutional analysis of how tax expenditures work in the United States. Tax expenditures are thought to be regressive, benefitting those with more resources. The general argument says that because tax expenditures are closely linked with employment compensation or spending, those who have jobs and get paid more or spend more will benefit more. Being able to pay less in taxes disproporationately benefits those who are better off — and also can take advantage of often complicated tax planning. A privatized welfare state administered through these coupon-like mechanisms, compared to public programs, involve less compulsory risk-pooling and more individualized risk-bearing, which also tend to benefit more affluent citizens.
Let’s take a closer look, using this great New York Times chart based on Tax Policy Center numbers, at who gains from different types of tax expenditures in the United States.
This chart examines five types of tax expenditures and the distributional consequences for each class. But it also shows which tax expenditures benefit three classes of people.
The first are tax expenditures that go to the working poor. These are focused on refundable credits, where almost 60 percent of them go to the bottom 40 percent of Americans. These tax expenditures are meant to help boost wages at the struggling bottom end, notably the Earned Income Tax Credit, which is a credit for low-income workers. The Tax Policy Center analysis shows EITC “on the table” to be cut under Romney, and it is telling that the Repbulican leaders haven’t said whether they want to cut the credit and seem to be dropping hints that they may go after those working-class “lucky duckies.”
The second set go to the middle class and upper-middle class, meaning people whose work requires at least some college education, often defined by longer-term employment or middle management positions. These expenditures largely represent itemized deductions and tax exclusions. As seen in the chart, over 50 percent go to taxpayers between the 80th and 99th percentile of income. These underpin the mainstays of middle-class existence: health care provided by employers and a home mortgage, both subsidized through tax deductibility.
Finally the third set go to the top one percent, focused on special treatment for capital and dividend income, which are taxed at a lower rate than wages. As those forms of incomes are predominately earned by the top one percent, the tax benefits mostly benefit that group. The top 0.1 percent earn more than half of this expenditure, with the top one percent taking home a total of 75 percent of the benefit. People working in elite financial positions often claim that their income derives from money rather than labor to qualify for this exemption.
Tax policy helps sustain each of these groups. Making low-wage work pay more, keeping the middle class in long-term employment relationships and making sure they are property-owning members of their communities, and increasing the financialization of the economy and the explosive wealth of the top one percent all are boosted by the government’s system of taxation.
With this framework in mind, what’s wrong with Romney’s plan? What the plan seeks is to reduce taxes on each group and make up the difference by reducing the tax expenditures received by each group. But remember that Romney doesn’t want to touch the tax expenditures in the third set — those aimed at savings, capital gains, and dividends, which go overwhelmingly to the top one percent. So he wants to lower taxes on the one percent, but he has to make the lost revenue up by cutting a set of tax expenditures that largely benefit either the working poor or the middle class.
So if you are going to “lower the rates and broaden the base” for the rich, you need to actually broaden the base for the tax expenditures that the rich receive. This will be true for all of these plans going forward, and especially for Romney’s. Otherwise, as the Tax Policy Center found, the exercise can’t actually work.
One question that the Tax Policy Center paper doesn’t address is whether the Romney plan is mathematically impossible, period. Would broadening the base on the third set of savings and investment income actually make the plan work? The 99 to 99.9 percent gain an average change in after-tax income of 3.5 percent, and the top 0.1 percent gain 4.4 percent, while everyone loses 1.1 percent under the Romney plan.
The answer may be found in another Tax Policy Center paper, “Distributional Effects of Individual Income Tax Expenditures: An Update” by Eric Toder and Daniel Baneman (p. 7), which indicates that eliminating tax preference for capital gains and dividends would reduce after-tax income by an average of 4.5 percent for the top 1 percent. That would get Romney most of the way to his goal, and perhaps removing exclusions for savings would make the entire plan work. If he lowered rates while broadening the base, however, reducing tax expenditures brings in less money. So even cutting the tax expenditures for the top one percent may still not make his plan work. It’s likely that these exclusions for savings and investments would be expanded, not cut, under any plan promoted by Romney and House Budget Committee chair Paul Ryan, but it is worth analyzing whether Romney’s plan could work at all, under any circumstances.
Mike Konczal is a Fellow at the Roosevelt Institute.
Cross-Posted From Rortybomb
The Roosevelt Institute is a non-profit organization devoted to carrying forward the legacy and values of Franklin and Eleanor Roosevelt.