Saturday, October 6, 2012

Romney's Base-Broadening Curiosity

There have been plenty of responses to the first Presidential debate.  Here is a play-by-play, in a sense, from Ezra Klein and his colleagues at the Wonkblog that goes through the basic assertions that were made, and gives background for each. 

But there is an economics-related curiosity about one of Governor Romney’s assertions---or rather, about a sequence of claims that he has made in the past and seemed to amend during the debate.  They lead to a theoretical peculiarity related to his purpose in lowering tax rates and “broadening the base”. 

During the debate Romney denied that he intends to implement a tax cut that could result in a $5 trillion loss of revenue over a decade.  But he has called for a 20% tax rate cut for every income level.  He has also called for eliminating the alternative minimum tax, cutting the corporate tax rate to 25%, and maintaining all preferential tax treatment of capital gains and dividends.  If you do the math, this does amount to about $5 trillion of tax cuts over the next 10 years relative to the current policy baseline, and even more compared to current law (which would allow the Bush tax cuts to expire at the end of this year).   Still, Romney claims that other changes he intends to make, changes to “broaden the base”, will offset his tax rate changes to make the whole package revenue neutral---meaning that it will neither raise nor lose revenue for the government.  

When he says he wants to broaden the base, I think he may be trying to give the impression that he wants to get the 47% of the population who he claims pay no federal income taxes toss some money into the pot so that he can reduce taxes for the other 53% of the population.  That’s been the long-held vision on the right: everyone should have “skin in the game”, they say, ignoring the fact that almost everyone already does have skin in the tax game.  Nearly all adult American pay taxes of some kind.   But in general, broadening the base doesn’t need to mean including people in the tax system that are not now included: it means including income that is not now included.  That income may be earned by the same people who are now paying taxes, but it is income that is now sheltered from taxes by some special tax code provision.  And that’s why Romney has been talking about eliminating deductions and exemptions and other tax breaks to make up the revenue lost by his tax rate change.  Most studies have concluded that there is no set of tax break changes that could make the whole package revenue neutral without raising taxes on the middle class, and reducing taxes on the wealthy, and there was a strong suspicion on the left that a tax reduction for the wealthy was Romney’s real purpose.

But during the debate, Romney claimed that he had no intention reducing taxes for the wealthy, and he denied absolutely that he ever intended to raise taxes on the middle class.  He gave the strong impression that when he said the plan would be revenue neutral, he meant neutral at every income level: that no income level would pay any more or less taxes than they do now.  So the question is: what is the point, then?  If everyone pays the same taxes after the long exhausting ordeal of changing the tax code, why are we doing it?  And the answer seems, from other comments Romney has made, and comments from others on the right, that the purpose is not to change total taxes paid, but to lower the marginal tax rates.  The idea is that people respond to lower tax rates by working harder or working more. 

And now we get to the curious part. 

What is a tax rate?  Is it the additional taxes paid on each additional total dollar earned, or is it the nominal rate on each additional taxable dollar earned?  Here’s an example to show what this means.  Suppose you earn $100 million per year, you have $50 million in deductions---I know that this is a realistic example for all of you who read this---and your nominal tax rate on each additional taxable dollar is 20%.  Your taxable income is $100M total earned income-$50M deductions=$50M taxable income; 20% of that is $10 million, or 10% of the your total earned income.  Now suppose we eliminate all tax deductions and reduce the tax rate on taxable income to 10%.  Now you earn $100 million, have no deductions, and pay 10% of your total income, or $10 million, in taxes. Your nominal rate on taxable income has decreased, but your total tax bill hasn’t changed at all, just as Romney promised.

But Romney seemed to promise during the debate that the total tax payment rate will not change at any income level.  So as you rise to higher and higher income levels, you pay the same total amount in taxes at each new level that you would pay under current law.  The actual tax rate on each additional dollar earned has not changed, even though nominal tax rates on taxable income are reduced, because more of your income is now considered taxable.   

The curious thing is the apparent belief that people will respond to the nominal rate on taxable income, rather than the actual tax rate on total income. 

So what do you think?  Is that true?  And if so, why is it true?  Is this a kind of tax-rate blindness?  Is our logical incentive, the marginal tax on total income earned, hidden behind a taxable-income tax rate veil?


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