I watched the debate the other night with a bunch of students and other seemingly normal people far outside of the DC beltway. After the debates were over, we talked about what we’d just heard and everyone was totally confused about Gov Romney’s tax plan. They just didn’t get how he’s going to a) lower tax rates by 20% for everyone, repealing the estate tax and the Alternative Minimum Tax while b) not losing any revenue to the system, and c) not raising taxes on households below $200,000.
Not unlike the President, they seemed deeply confused by the fact that he’s been running on a big tax cut but now seemed to saying…”not so much.”
The fact that you find this confusing is actually a good sign. There’s solid math that says he can’t accomplish all three—more of that in a moment. But here’s a revealing quote from Gov. Romney in last week’s debate:
“I will not reduce the taxes paid by high-income Americans.”
The group found this especially confusing. When is a tax cut not a tax cut?
First, you have to understand that Mitt Romney makes a very big distinction between your tax rates and your tax liability. And in a system like ours with lots of tax deductions and credits, there’s often a difference between the two, especially if you itemize on your return. That’s why people with high incomes—people you’d expect to pay a lot more in taxes because their tax rates are the highest—often face tax bills that are a much smaller share of their income than you’d expect. It’s because of the deductions and favorable treatment of various types of income, like capital gains and dividends.
So, one reason why Romney was so confusing in the first debate—aside from the fact that he made a bunch of stuff up—was that most people think about their taxes in terms of their tax liability, i.e., the check they have to write to Uncle Sam come tax day. But that’s not how he thinks about it. He’s deeply bought into the notion that what really matters to people are their rates, not their liabilities. So, in his world, he can make you better off by lowering your rate, even if he then takes back what he just gave you by closing a loophole from which you benefit.
But besides being disconnected from most people’s experience, this is also where his numbers problem comes in. His plan really does cost $5 trillion over ten years and it’s just deeply misleading when he says it doesn’t. If you take the numbers from the Tax Policy Center and the Treasury (for the elimination of the estate tax), the 10 year costs break down like this:
- Lower tax rates by 20 percent = $2.5 trillion
- Eliminating the Alternative Minimum Tax = $700 billion
- Repeal of high-income payroll tax = $300 billion
- Repeal the estate tax = $150 billion
- Tax cut for corporations = $1.1 trillion
The interest costs get you to $5 trillion.
Of course, Gov. Romney claims he can offset that cost with base broadening: ending tax deductions, closing loopholes, getting rid of preferences that high-income taxpayers currently tap to great effect to lower their tax bills.
But my liquidity analysis shown here still holds. Families with incomes over $200,000 receive $2.7 trillion of the various breaks noted above and only $1.7 trillion in tax benefits (not counting special treatment for investment income, which Romney has promised not to touch). That $1 trillion difference has to come from somewhere or the revenue neutrality is lost, but since “somewhere” has to by definition include the “middle class” (households earning less the $200,000), that violates a different part of his pledge.
Regardless of his claims in the debate, Romney can’t square this circle. Instead, what I fear will happen if he gets a chance to implement this idea in the current anti-tax climate is the classic tax reform trap I’ve written about many times. You promise lower rates paid for by a broader base, but what you end up with is just the lower rates, not the broader base. It’s a recipe for larger deficits and great after-tax inequality.
Finally, and this is very important, do we really need more large, permanent tax cuts? Romney’s essentially talking about another GW Bush-sized tax cut on top of making the Bush one permanent. Why would anyone other than a devout supply-sider impervious to the evidence of the Bush years want to go there, unless, like those with incomes above $3 million a year, they’re slated for an average tax break of $250,000?
And according to Gov. Romney, even they should think twice, because they’re not getting a tax cut, as in the quote above from the debate. I suspect any of them who were listening didn’t believe him on that point, and I’m afraid they were right not to.