Wednesday, August 08, 2012

Mitt Romney, taxer of muni bonds?

Oh, the distortions, sleights of hand and outright falsehoods in the Wall Street Journal editorial board's ridiculous attempt to take down the Brookings/Urban League Tax Policy Center finding that the Romney tax plan would cut taxes for the wealthiest 5% and raise them for everyone else.  The falsehoods are macro, micro and legion.

Let's start with the premises on which the TPC analysis of Romney's purposefully vague tax plan (p. 38 ff) are based. Because Romney does not specify what tax deductions he would reduce or eliminate, or for whom, TPC extrapolates from broad principles he's laid out:

a revenue-neutral individual income tax change that incorporates the features Governor Romney has proposed -- including reducing marginal tax rates substantially, eliminating the individual alternative minimum tax (AMT) and maintaining all tax breaks for savings and investment -- would provide large tax cuts to high-income households, and increase the tax burden on middle- and/or lower-income taxpayers (p. 1).
While every neutral report of the TPC analysis has noted that the TPC bent over backwards to make assumptions favorable to Romney -- assuming that he would close loopholes for the wealthy first to the extent his ground rules allow him, and even granting "dynamic scoring," i.e. revenue estimates that allow for projected strong growth, the Journal pooh-poohs any effort to fill in Romney's blanks:
The plan says these [marginal rate] cuts would be financed in a revenue-neutral way. First, by "broadening the tax base," which means reducing or eliminating tax deductions and loopholes as in the tax reform of 1986. The Romney campaign doesn't specify which deductions—no campaign ever does—but it has been explicit in saying that the burden would fall most on higher tax brackets. So in return for paying lower rates, the wealthy get fewer deductions. 
"No campaign ever" specifies tax deductions it would close or reduce --except, for one, the Obama campaign. Obama's 2013 budget calls for reducing the value of itemized deductions and other tax preferences for families with incomes over $250k to 28%, projecting a deficit reduction of $584 billion over ten years. It also proposes capping deductions to those earning over $1 million so that they pay a minimum of 30% of their income -- an unscored deduction reduction, and perhaps an unwise one, but quite specific. The Obama budget also calls for ending the Bush marginal tax cuts for the top 2% and restoring the estate tax exemption and rates to 2009 levels -- not deductions, it's true, but concrete, scoreable tax proposals estimated to reduce the deficit by just short of $1 trillion in 10 years (pp. 39-40). 

The Journal editors then take a potshot that's meant to explode an inconvenient truth in the TPC analysis: that whereas the Bowles-Simpson plan raised taxes more on the wealthy than on the middle- and lower classes, Romney's plan would do the opposite.  The potshot is aimed at a middleweight tax break:
The class warriors at the Tax Policy Center...issue the headline-grabbing opinion that it is "mathematically impossible" to reduce tax rates and close loopholes in a way that raises the same amount of revenue. They do so in part by arbitrarily claiming that Mr. Romney would never eliminate certain loopholes (such as for municipal bond interest), though the candidate has said no such thing.
Why focus on municipal bond interest? It is the smallest item in a trio of investment-related loophole closures or reductions in the Bowles-Simpson plan, which would raise serious revenue by (if I may self-plagiarize), 1) taxing all capital gains and dividends at ordinary rates -- that is, at 28% for top earners, as opposed to the current 15% rate; 2) making state and municipal bonds taxable; and 3) reducing the allowable deductions for retirement account contributions.

Why do the WSJ editorialists not focus on TPC's assumption that Romney would not tax investment income as ordinary income, which would raise four times as much revenue as making state and municipal bonds taxable? Because that assumption is incontrovertible -- Romney explicitly says that he will not change the capital gains/interest income rate. TPC infers that Romney would not make municipal and state bonds taxable from Romney's stated general principles, such as "Further Reduce Taxes on Savings and Investment," a subhead in the sketchy tax section of his 59-point economic plan.

Never mind that no one in their right minds could envision Romney (or frankly, I suspect, any other U.S. politician) seeking to eliminate the tax-free status of state and municipal bonds. The WSJ editorial board is devoted to promoting a Romney fiction: "The Romney plan of cutting the top tax rate to 28% and closing loopholes to pay for it is conceptually very close to what Simpson-Bowles recommended."  They therefore conjure away a core difference: that Bowles-Simpson raises serious revenue by raising taxes on savings and investment income, and Romney will not. And another: that Bowles-Simpson spells out its loophole closures and reductions and is therefore able to specify that its tax proposals would reduce the after-tax income of the top 1% of earners by 7.8% (and that of the top 0.1% by 11.8%).

In an appendix, TPC spells out the tax breaks it assumes that Romney won't touch:
Preferential rate on capital gains and dividends
Exclusion of interest on tax exempt municipal bonds
Deduction for HSA Contributions from taxed income
KEOGH, SEP, & Simple Contribution Deduction
Penalty on Early Withdrawal of Savings
Self-Employment IRA Deduction
Investment Interest
Saver’s Credit
Capital gains exclusion on home sales
Step-up basis of capital gains at death
I'd like to see anyone argue with a straight face that Romney is likely to end or reduce any of those breaks.

I'm sure that economists can and will do a better job than I debunking the other fundamental bait-and-switches on which the Journal editorial depends. One includes conflating broad historical trends with the likely outcome of Romney's specific plans:
The Tax Policy Center also ignores the history of tax cutting. Every major marginal rate income tax cut of the last 50 years—1964, 1981, 1986 and 2003—was followed by an unexpectedly large increase in tax revenues, a surge in taxes paid by the rich, and a more progressive tax code—i.e., the share of taxes paid by the richest 1% rose.

For example, from 1980 to 2007, three tax rate cuts brought the highest marginal tax rate to 35% from 70%. Congressional Budget Office data show that when the tax rate was 70%, the richest 1% paid 18% of all federal income taxes. With the rate down to 35% in 2008, the share of taxes paid by the rich doubled to 40%.
The "example" ignore the fact that the share of wealth captured by the rich more than doubled from 1980 to 2007. (It's true that the tax code grew modestly more progressive over that span, but not nearly enough to offset the surge in income inequality.) It also limits the calculation to income taxes, whereas Social Security reform in the 1980s increased the proportional bite taken out of more modest paychecks by FICA taxes.   Finally, it ignores the defining feature of Romney's plan according to TPC, which is that it rules out reducing incentives for investment income and savings, tax breaks that overwhelmingly favor the rich.

Finally, the Journal editorialists wheel in a deus ex machina: dynamic scoring, the crediting of turbo-charged economic growth resulting from the plan's tax changes. On that front, they falsely assert: 
The study's claims also rest on the assumption that tax cutting doesn't increase economic growth. The study's authors expose their own bias on this point by asserting that "the effects of tax rate reductions are likely to be small or even negative" over 10 years. 
The authors conveniently ignore, not only the citation of research backing that claim, but TPC's grant of dynamic scoring assumptions that follows immediately after the cited passage:
Nevertheless, the above results are not qualitatively different even if one were to assume that tax cuts pay for themselves according to the rule of thumb estimates from Mankiw and Weinzerl (2006). This model, which is based on an assumption that saving is infinitely elastic, may well overstate the capital income response, in addition to the other concerns raised above. Moreover, this model that assumes that rate reductions are paid for with lump sum tax increases, which means their model would overstate the growth effects in the context of a tax plan that included progressive reductions in tax expenditures.

If we assume, as in their model, that 21.3 percent of capital income taxes and 13.5 percent of labor income taxes are offset by higher growth after five years this would imply a revenue offset of 14.7 percent. (Assuming the tax cuts are 85 percent labor and 15 percent capital, which is roughly the share of labor and capital income reported on individual tax returns).[21]

According to this assumption, the tax cuts would result in revenue reductions of $307 billion (instead of $360 billion). If we assume that base broadening therefore only needs to pay for $307 billion in revenues (after five years), even in this scenario, more than 56 percent of all available tax expenditures would need to be eliminated (versus 65 percent without this assumption). Although a tax reform would need to raise $53 billion less through base-broadening, this is not be enough to offset the $86 billion net tax increase faced by lower- and middle-income households in the analysis above. Indeed, in this example, even if all of the additional economic growth accrued to high-income taxpayers, and all of the additional revenue were paid by high-income taxpayers, high-income taxpayers would still experience a net reduction in their tax payments. Thus, even in this case, the required base broadening still results in a net tax reduction for the top 1 percent and for taxpayers making more than $200,000, and a net tax increase on taxpayers earning less than $200,000.
The Journal editorialists don't grapple with this math. Why should they? They've cast doubt on Romney's unwillingness to tax municipal bonds.

Update, 8/9: I see via Political Animal that Jonathan Chait did a takedown of this editorial before I got mine down yesterday evening. I might have known, since a) my first thought when I read the piece yesterday morning was "Chait bait" (I almost tweeted as much), and b) in the evening, I jumped into a Chait twitter string to ask about something I had checked out earlier in the day in preparation for my post: whether Romney's campaign documents rule out new taxes on investment income as sweepingly as TPC language suggests (not quite, as the post suggests).  It now seems silly to me that I did not infer from the email string that Chait had already written about the editorial, but I didn't -- just plowed in after dinner to write a post I'd sketched out in the a.m. (using a reference in the Romney econ plan that Chait kindly supplied in a tweet).  In any case the two pieces seem complementary to me. 

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