As the campaign heats up and the Congress continues its inability to set partisanship aside to consider the well-being of the country, we can expect continued emphasis on tax rhetoric without much tax substance.
On the one hand, Obama appropriately argues for higher taxes on the well-to-do, but doesn't seem to be making much use of the bully pulpit to help Americans understand the importance of that approach. Obama ought to be arguing for elimination of the capital gains preference across the board, but he is already losing out on fundraising amongst the banksters, so that argument is not likely to be made.
On the other hand, Romney says he is going to solve all of our problems by lowering taxes even more on his peers, the wealthy, while paying for it by eliminating unnecessary tax expenditures. The tricky thing about "lowering rates, by eliminating tax preferences" is that you have to decide (1) who gets lower rates and (2) which tax preferences get cut. Without that info, you've just got an abstract theory about tax reform, not a real proposal. And of course, if you cut tax rates at the top, thus favoring the wealthy, while not eliminating the tax preferences that are most beneficial to them, you upend the progressivity of the income tax system at the same time. So specifics really matter here.
Thankfully, there's a new study that sheds some light on the tax preferences/rate cut scenarios. The Tax Policy Center issued a new report , prepared by Hang Nguyen, James Nunns Eric Toder and Roberton Williams, on July 10 entitled "How Hard Is It To Cut Tax PreferencesTo Pay For Lower Tax Rates?" The abstract makes clear that this is not the easy solution so often claimed.
Some political leaders have proposed to lower individual income tax rates and make up the lost revenue by eliminating tax preferences. To help inform the discussion of such proposals, we examine illustrative revenue-neutral combinations of lower rates and cuts in tax preferences and their effects on the distribution of tax burdens. We conclude that paying for lower rates would require substantial reductions in broadly-used and popular preferences. In addition, requiring that changes maintain the current progressivity of the federal income tax would make it much harder to find a politically acceptable mix of preferences to curtail.
The article starts out with a typical "efficiency" oriented statement about taxes.
"High tax rates reduce incentives to work, save and invest, encourage tax evasion and avoidance, and magnify the distortions caused by the myriad tax preferences in the current income tax. An enduring goal of tax reforms has consequently been to broaden the income tax base to pay for lowering tax rates." Id
But guess what. That statement isn't clearly true. The idea that taxes "reduce incentives" to work, save, invest" and "magnify distortions" and therefore an appropriate goal is to lower tax rates rests on economic models about market efficiencies that are, quite simply, unproven. If taxes are so terrible, we should have terrible economic results in periods of high tax rates and much better economic results in periods of low tax rates. Of course, we can't ever undertake an experiment to prove or disprove this, since there are many other variables--including how those taxes are spent in furtherance of a more vigorous and sustainable economy-- and those are impossible to control. But we can look to historic evidence to see if high tax rates have correlated with poor growth and low tax rates with high growth, which would tend to prove the statement. MIke Kimel's book on Presimetrics examined a wide range of correlations, and showed the statement doesn't hold--high tax rates, in fact, have correlated with good growth.
That doesn't mean that broadening the base by getting rid of wasteful or distributionally unfair tax preferences wouldn't be a good idea. Many of these preferences are of the most value to the wealthy, and mean very little to ordinary taxpayers--such as carried interest capital gains rate for private equity fund managers. Many of them are outdated, representing old industrial policy that should have given way to newer ideas long ago--such as the various subsidies in the system for natural resource extraction (favoring Big Oil). Many of them are examples of the worst of crony capitalism, such as the charitable contribution deduction for the value (not investment) of stocks that only the very rich receive much benefit from (because they own most of the financial assets). Some of the worst tax preferences are those that favor the wealthy--the capital gains preferential rate, that provides a tax break to the wealthy who can structure their income in ways unavailable to ordinary folk and who own most of the financial assets (and so get the lion's share of the capital gains rate benefit).
The Tax Policy Center study suggests it would be fairly hard to get more than a trillion out of eliminating tax preferences if tax rates are cut at the same time, for the following reasons:
1) if you lower tax rates, the savings from eliminating tax preferences is reduced, since the biggest cost of preferences is to those at the top of the rate scale.
2) even if you know that a tax preference "should" be eliminated, you are likely not going to be able to eliminate it because the interest group benefited by it will protest, loudly (the charitable contribution deduction for stock contributions, for example), or because it is administratively impractical to impose tax on the preference item (home rental value, for example)
3) if you eliminate a tax preference and lower the rate, you may shift more of the tax burden to groups that shouldn't bear it (the lower income classes, for example, in the case of the Earned INcome Tax Credit or the Child Credit)
4) If you repeal existing preferences without transition rules, you change economic outcomes in ways that may be resented, but if you transition in gradually over time and without complete repeal, you will likely not get the revenue gains desired to support cutting rates.
The report looks at three scenarios:
- "current law" (in which the Bush tax cuts end at 2012 year-end--39.6% on ordinary income and dividends and 20% on capital gains and where the personal exemption phase out and limitation on itemized deductions increase revenues from higher-income taxpayers);
- "current policy" (in which the temporary rates in effect today--35% top rate on ordinary income and 15% preferential rate on capital gains and dividends and the AMT exemption indexed for inflation); and
- "current policy with reduced rates" (in which ordinary rates are cut further to a top rate of only 28%, the capital gains and dividend preferential rate is retained at 15%, and the AMT is repealed--i.e., Romney's tax proposal as to rates, except that he would also repeal the estate tax, reduce the corporate tax rate, make the corporate tax system territorial, and have a zero rate on capital gains and dividends for those with incomes below $250,000--though he has not identified which tax preferences he would eliminate in order to make such a drastically reduced tax intake revenue neutral).
The report notes that the differences in rates under each of these approaches is significant.
The difference between effective tax rates under Current Law and under Current Policy and Current Policy with Reduced Rates generally increases as income rises (Chart 4). For example, the difference in ETRs for the lowest quintile under Current Law and Current Policy is 2 percentage points, while the difference for the highest quintile is 3.4 percentage points and that for the top 0.1 percent is 4.5 percentage points. That increasing reduction in effective tax rates across income categories indicates that the tax system becomes increasingly less progressive across the three tax laws.
The report considers the 173 tax expenditures in four groups based on prevalance of proposals for repeal and limitation and administrative feasibility:
(a) itemized and above-the-line deductions, non retirement fringes and small credits;
(b) investment and retirement income (items that favor saving by individuals);
(c) child, work-related, and social security benefits ("provisions that primarily help low-income households, families with children, and low-to moderate-income Social Security beneficiaries");
(d) Other preferences (various exclusions from taxable income such as capital gains at death and on home sales; imputed rent; cash benefits for low-income families; veterans' benefits; inside buildup of life insurance).
The report doesn't consider business tax expenditures and doesn't consider payroll taxes.
They conclude that
Current Policy with Reduced Rates could meet the Current Policy revenue target with a significant curtailment of some of the largest tax expenditures, such as mortgage interest, charitable contributions, and employer-provided health insurance. However, these are widely used and popular provisions, so sharply limiting their value could prove difficult. Further, this combination of lower rates and a broader base would cut taxes substantially for high income taxpayers, resulting in a less progressive tax system than under Current Policy.
With sufficient base broadening, tax rates under both Current Policy and Current Policy with Reduced Rates could raise the same amount of individual income tax revenue as Current Law. However, meeting that goal under Current Policy would require a sharp curtailment of mortgage interest, charitable contributions, and employer-provided health insurance. Hitting that revenue target under Current Policy with Reduced Rates would be even harder. It would require curtailment of these same popular tax expenditures as well as substantial reductions of additional tax expenditures, such as the special rates for capital gains and dividends, the exclusions for retirement contributions and earnings, and possibly such items as the earned income tax credit (EITC), the Child Tax Credit, and the exclusion of some or all Social Security benefits for low- to moderate-income beneficiaries. From a political perspective, matching Current Law revenue would be difficult, if not impossible.
ASIDE: Meanwhile, Romney continues to clam up about his failure to release more than one tax return and the fact that even tax experts cannot get much of an idea why he has put so much of his fortune in offshore tax havens (Bermuda, Caymans, Swiss banks). Then there's the question of how an IRA got to be worth $102 million in such a short time--without seeing 10 years of tax returns, it is hard to say how that could be and easy to question whether there some slippery manipulation of asset values at the time of putting them in, so that it looks to have gotten super-extraordinarily splendid returns. One of the problems of having a presidential candidate with so much wealth is that he (1) is great friends with the banksters and thus able to use all the tricks of the trade --which may or may not be legal but one has to question their advisability for a president; and (2) is so accustomed to getting his own way that he is tone deaf to the justifiable interest that Americans have in how he made so much money and what he chooses to do with it.
Not to mention, of course, his inability to explain away his signing off on SEC and other federal forms as sole shareholder, CEO and manager of Bain Capital through 2002, while claiming to have exited Bain in 1999 so as to avoid blame for the even worse leveraging carried on by the private equity firm, which resulted in a good deal of outsourcing and US job losses. His way of dealing with that was to call Obama a liar by raising the issue, but that doesn't fly, since the issue is there and should be dealt with head on by releasing tax returns, among other efforts towards transparency.
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