Now that was a debate; contentious, revealing, and filled with acrimonious exchanges between two candidates who could barely conceal their distaste for one another. If this were wrestling, Joe Biden would have concluded the night by beating Paul Ryan senseless with a coconut, a la Rowdy Roddy Piper. Tonight was, in short, everything the Obama-Romney debate wasn’t.
Before we get to the tax issues, a couple of quick thoughts:
- What a difference it makes to have a moderator that controls the flow of the discourse and asks the questions the public wants to hear. Great job by Martha Raddatz.
- While Obama’s campaign advisors may well have urged him to remain “Presidential,” they were apparently more than happy to take the reins off Joe Biden. Biden attacked everything we expected Obama to address: Romney’s infamous “47 percent” comment, his 13% effective tax rate, and his continued protection of the preferential tax rates afforded “carried interests” — often in an aggressive, accusing manner. (For more on carried interests, click here).
- While Biden’s candor was refreshing, his decorum was decidedly less so. Kudos to Paul Ryan for not getting angrier than he did with Biden’s constant laughing and gesticulating while Ryan was speaking. Ryan did strike a blow with that “I think the vice president very well knows that sometimes the words don’t come out of your mouth the right way” shot, but for whatever reason, it came off more as over-rehearsed and ill-timed than a memorable one-liner.
- Regardless of your political leanings, it’s hard to argue that Biden didn’t have the response of the night when he replied to Ryan’s criticism of the President’s stimulus spending by pointing out that Ryan had written him letters on two occasions imploring Biden to send stimulus money to Ryan’s home state of Wisconsin. To be fair, Ryan had to know Biden’s response was coming, but he was obligated to address the Obama administration’s rampant spending.
Now, on to the tax issues addressed throughout the debate; specifically, what did voters learn about the future of tax policy?
Joe Biden and the $500 Billion Tax Cut for the Wealthy
Tax policy made its first appearance earlier than anticipated, during a discussion on unemployment. Shortly after an impassioned rant about what he perceived to be Romney and Ryan’s apathy towards 47% of Americans, Biden added:
“They’re pushing the continuation of a tax cut that will give an additional $500 billion in tax cuts to 120,000 families. And they’re holding hostage the middle class tax cut because they say we won’t pass — we won’t continue the middle class tax cut unless you give the tax cut for the super wealthy.”
Unfortunately, debates don’t come complete with citations, so the viewing public was likely left struggling to make sense of the genesis of Biden’s statistics. Lucky for you, I’ve got a winning combination of an abundance of free time and a very understanding wife, so I’ve gone ahead and done the legwork for you.
As I discussed in detail here, the Bush tax cuts are set to expire on December 31, 2012. Should that occur, the top individual tax rate will rise from 35% to 39.6%, the next highest rate will jump from 33% to 36%, and each lower bracket will experience an increase as well.
Currently, the primary point of contention between Republicans and Democrats is what to do with those top two tax rates. The President wants to allow those two highest rates to reset to 36% and 39.6%, respectively, while preserving the reduced tax rates from the Bush-era for all of the lower tax brackets. Effectively, this would raise taxes in 2013 on only those taxpayers earning in excess of $200,000 ($250,000 if married filing jointly).
Republicans, on the other hand, have refused to allow an extension of the lower tax rates unless the two highest tax brackets are extended along with them.
So where does the $500 billion come in?
According to the President’s budget for the period 2013-2022, continuing the Bush tax cuts for those earning in excess of the $200,000 threshold — approximately 2% of the population — would cost the government $968 billion in revenue. Click the image below to enlarge the chart taken from the Budget proposal.
A separate study published by the Tax Policy Center indicated that 55% of the total benefit enjoyed by those top 2% of taxpayers that would be impacted by the expiration of the 33% and 35% brackets would inure to the top 0.1% of the population. The TPC then added that the top 0.1% of the population consists of approximately 120,000 taxpayers.
From there, Biden just does some basic math. $968 billion total benefit for the top 2% x 55% enjoyed by the top 0.1% = $532 billion benefit for the top 0.1%, or 120,000 families — if the Bush tax cuts are extended for all taxpayers.
This would be a statistic repeated several times throughout the night, and it served as the foundation for the ensuing argument, in which Biden accused Ryan and Romney of holding the middle class hostage by refusing to extend the Bush tax cuts for the lower brackets, while Ryan responded by claiming that the additional $968 billion in revenue generated by allowing the cuts to expire for the top 2% wouldn’t put a dent in the deficit.
So who’s right?
Quite frankly, they both are.
There really is no compelling need to extend the Bush cuts for the top 2%, unless you are a firm believer that a lower rate will stimulate economic growth, and many are. The idea fronted by blowhards like Bill O’Reilly that if you tax “the achievers,” they’ll simply stop achieving, is spurious and laughable. Rates have been as high as 70% under the Eisenhower administration, and best I can tell, no leading minds of that era put down their pencils and said “To hell with this… I was going to invent the Atari 2600, but a 70% tax rate? Forget it. I’ll just go back to bed.”
But Ryan is also dead on in his analysis: $968 billion — assuming that number is accurate — would not make a dent in our ever-growing deficit. If the Obama administration is serious about reducing the deficit, there would have to be significant spending cuts to make up for the fact that the top 2% simply isn’t big enough to foot the additional tax bill necessary to eat away at our mounting debt.
Of course, arguing that since the $968 billion of additional revenue wouldn’t make a dent, we needn’t bother to collect it isn’t the soundest fiscal argument either, but I get Ryan’s point. A recent study by the Tax Foundation suggested that simply by cutting the top tax rate to 28%, you could grow the GDP by 7.4% over a 5-10 year window, so perhaps Romney’s plan to cut rates and recover revenue through economic growth has merit. The problems that come with this proposal, as we’ll discuss shortly, lay in its implementation.
But here’s the real oddity of this portion of the debate: Romney’s tax plan does not involve extending the Bush tax cuts for the rich. It involves extending the tax cuts for all taxpayers, then reducing the Bush-era tax rates by an additional 20% across the board. As President Obama referenced several times during the presidential debate, this is expected to cost the government $5 trillion in tax revenue over the next decade, with nearly $2.4 trillion of that benefit going to the wealthiest 2% of taxpayers according to the now-famous Tax Policy Center study. This is a much more meaningful reduction in revenue — and potential corresponding increase to the deficit — then the $500 billion number Biden focused on.
Of course, as we discussed with regards to the previous debate and will do so again below, the Romney campaign promises to pay for any and all lost tax revenue with offsetting reductions or caps to deductions, making the $5 trillion tax cut — in their eyes — no tax cut at all. And while the two candidates did eventually get to discussing this rather important detail, it was through no impetus of their own, but rather the urging of Raddatz. Instead, the voting public had to watch the two candidates debate the merits of a tax plan that is not currently on the table, which likely only served to confuse.
How Do You Define Small Business?
Later in the night, when the discussion formally turned to tax policy, Ryan was asked by Raddatz what portion of the population would pay more, and what portion would pay less, in tax if Romney were elected. Ryan responded:
“Our entire premise of these tax reform plans is to grow the economy and create jobs. It’s a plan that’s estimated to create 7 million jobs. Now, we think that government taking 28 percent of a family and business’s income is enough. President Obama thinks that the government ought to be able to take as much as 44.8 percent of a small business’s income.”
Now, if I were sitting at home (I was) and owned a small business (I don’t), I would take this to mean that my tax rate was about to approach 50%. But there’s an issue of semantics that needs to be addressed:
When Romney and Ryan refer to “small businesses,” they are actually referring to the 36 million taxpayers who report their business income directly on their individual income tax return, and are therefore subject to the individual tax rates at the center of this debate. These business types include sole proprietorships, single-member LLCs, Subchapter S corporations, and partnerships.
What these business types have in common is that they do not pay tax to the government on their own behalf — unlike a Subchapter C corporation, which computes and pays its own tax at the corporate income tax rate — rather, the income of the business “flows through” and is taxed at the individual owner level.
But here’s the issue: of the 36 million taxpayers who own sole proprietorships, single-member LLCs, or an interest in a flow through entity, only 900,000 — or 2.5% — actually pay tax at the two highest tax rates. Stated in another manner, by allowing the Bush tax cuts to expire for those individuals earning more than $200,000, only 2.5% of all “small businesses” would actually pay higher taxes in 2013 than they do today. The other 97.5% of small business owners will pay the same 28% or lower tax rate that they pay today, assuming, of course, the Bush tax cuts are extended for all taxpayers earning less than $250,000.
Don’t believe me? Click to enlarge the chart:
And this is precisely the point Biden should have addressed. With Ryan accusing the President of raising taxes on small business owners, Biden should have been poised to react. And while he did point out that the expiration of the Bush tax cuts for the top 2% would impact only 2.5% of small businesses, he should have added that if the Republicans continue to refuse to extend the Bush tax cuts for the lower brackets, then all small business owners will pay more tax in 2013, as the current rates of 10/15/25/28/33/35% will reset to 15/28/31/36/39.6%.
The Competing Goals of Focused Deduction Elimination and Tax Reform
Soon after the small business conversation, Moderator Raddatz delivered where Jim Lehrer failed miserably in the presidential debate by asking Ryan exactly how Mitt Romney plans to pay for his proposed 20% across-the-board tax cuts. [As a reminder, the reduction in tax rates is expected to cost the government approximately $5 trillion over the next decade, but Romney has promised to offset the lost revenue with additional revenue raisers] Unfortunately, Ryan’s response was nothing more than a vague string of misdirections, devoid of the details tax policy experts — and informed voters — have long coveted:
” Look — look at what Mitt Romney — look at what Ronald Reagan and Tip O’Neill did. They worked together out of a framework to lower tax rates and broaden the base, and they worked together to fix that. What we’re saying is, here’s our framework. Lower tax rates 20 percent. We raised about $1.2 trillion through income taxes. We forego about $1.1 trillion in loopholes and deductions. And so what we’re saying is, deny those loopholes and deductions to higher-income taxpayers so that more of their income is taxed, which has a broader base of taxation..so we can lower tax rates across the board. Now, here’s why I’m saying this. What we’re saying is, here’s the framework…Mitt — what we’re saying is, lower tax rates 20 percent, start with the wealthy, work with Congress to do it…
Now, before I continue, let me remind you that I’m not an Obama guy, I’m not a Romney guy, I’m a tax guy. (in fact, I plan on voting for Kodos) And here’s why you should care about this portion of the debate if you’re a voter.
The vagueness of Romney’s plan is more than frustrating; it is also misleading. For example, a middle-class taxpayer may vote for Romney believing he is voting for a reduction in his top rate from 28% to 22.4% that will leave him with additional after-tax income. However, depending on which deductions are eliminated or capped in order to make the plan revenue neutral, the taxpayer may actually see his federal tax obligation increase, despite the reduced rates.
Because Romney and Ryan have no plan for how they will generate the additional tax revenue necessary to offset the revenue lost to the rate cuts, they can’t possibly promise anyone what the effect of their tax plan will be. They cannot guarantee that those earning in excess of $250,000 won’t see their overall tax share go down, though that hasn’t stopped them from trying. They can’t guarantee that the middle class won’t see their tax obligation increase, though that hasn’t stopped them from trying. They can’t promise any of these things, because they have no idea how the plan will work.
Just one week ago, Romney used the Presidential debate to introduce the idea of capping certain deductions rather than eliminating them, which was taken seriously enough that Bloomberg had yours truly run a bunch of numbers quantifying what a cap would mean to the middle class. Yet tonight, Ryan made no mention of this potential $17,000/$25,000/$50,000 cap, and instead focused again on eliminating deductions. Either Ryan and Romney aren’t on the same page, or, much more concerning, there is no page.
Is it mathematically possible to fully pay for a 20% reduction in tax rates by eliminating deductions? Probably, as we’ve already covered that here. Is it possible without shifting a portion of the tax burden from those earning in excess of $250,000 to those earning less than the threshold? That’s up for debate, but it would require an extreme top-down approach, where the wealthy lost all their deductions first, and even then the result is in question. But the point is, neither Romney nor Ryan can know it’s possible, because they have no plan, only a framework.
And as a voter, you must keep this in mind, because you may be enticed by the promise of a 20% reduction in your tax rate, only to discover in April 2014 that your mortgage interest or state tax deduction is of limited or of no use, and your tax obligation has actually increased over prior years.
What I find most frustrating is that the calendar has turned to October, and I still can’t formulate an opinion as to whose tax plan — Obama’s or Romney’s — I prefer, solely because I don’t know exactly what Romney’s plan entails. Obama’s plan is unappealing to me for a number of reasons — not the least of which are the potentially damaging effect on the deficit and the painful “Obamacare” surcharges — but at least it’s a known quantity.
One final thought for other tax eggheads: the idea that Ryan mentioned this plan and “tax reform” in the same breath is borderline offensive. True tax reform entails removing some of the countless loopholes from the Code for good, leaving the tax law more manageable than it was before. What Romney and Ryan are promoting is complexity to an unimaginable degree, attempting to cap certain deductions for a certain part of the population, while leaving the deductions in the Code for other taxpayers to enjoy.
On the bright side, it would keep me swimming in business.