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Posts Tagged ‘republican’

When I want to get my fill of nonpartisan tax discussion, there’s nothing that gets the job done quite like the Tax Policy Center. It’s always filled with rich, creamy tax goodness, and today is no exception.

As we’ve pointed out on more than one occasion, the biggest problem we have with Republican presidential candidate Mitt Romney’s tax proposals is whether it’s realistic to believe that they can be instituted on a revenue-neutral basis, as Romney claims.

As a reminder, Romney would slash the current tax rates by 20% — leaving us with a maximum individual income tax rate of 28% — while also eliminating the tax on interest, dividends, and capital gains for those earning less than $200,000. Romney has promised to pay for the cuts by broadening the tax base by eliminating popular deductions, but he’s never clarified what deductions would have to go. Nor have we ever seen a study formally quantifying 1) the cost of the proposed rate cuts in terms of lost revenue, and 2) the offsetting revenue that can be gained by putting an end to some of the larger deductions; namely, the deductions for mortgage interest, state and local taxes, and charitable contributions.

As we wrote back in May, the concern is not whether broadening the base enough to offset the revenue lost from rate cuts is mathematically possible, but rather whether its realistically feasible given all the factors working against eliminating deductions: special interest groups, the need to curry votes, matters of public policy, etc…

Well, the brilliant minds at the Tax Policy Center have once again done the dirty work for us. They took a good, hard look at the theory of broadening the base enough to pay for a 20% across-the-board tax cut, though they did so without formally examining Romney’s specific proposal.

To start, the Center echoes our concerns about the reality of cutting popular deductions, while adding some additional roadblocks to the equation:

1. Lower rates reduce the value of most tax preferences. Nearly all tax expenditures are in the form of deductions, exclusions, exemptions, deferrals, or preferential rates, all of which are valuable only to the extent they allow taxpayers to avoid regular statutory tax rates. If tax rates are cut, the value of these tax preferences goes down as well. Thus, cutting tax rates reduces the amount of offsetting revenue that cutting tax preferences can raise.

[Ed note: this is the tax equivalent of the dog chasing its tail. As the rates get cut, so does the revenue raised from cutting $1 of expenses. To illustrate, if tax rates are currently 35%, a $100 mortgage deduction would yield $35 of lost revenue. However, if the tax rates are cut to 28% and the mortgage deduction is eliminated, while you are losing 7% tax revenue on the income side, you are not gaining up $35 of revenue by getting rid of the mortgage interest deduction. You’re only gaining $28, the value of the deduction under the new tax rate.]

2. Some tax preferences may be hard to curtail for political or administrative reasons. For example, cutting back widely used and popular preferences such as the deductions for mortgage interest and charitable contributions may be politically difficult. If such preferences can’t be curtailed as part of a realistic tax reform, it becomes harder to find the revenue needed to pay for lower tax rates.

[Ed note: this has always been Issue #1 I have with the Romney proposal. Is he really going to win election, immediately cut the rates, and then tell his Republican constituents to bid farewell to their beloved mortgage interest deduction? Doubtful.]

3. Cutting back on tax preferences may alter the distribution of the tax burden in ways that are deemed unacceptable. Finding a combination of lower rates and cutbacks in tax preferences with acceptable distributional effects can prove quite difficult.

[Ed note: Stated differently, cutting tax rates and broadening the tax base usually leads to a disproportionate result: the taxes of the wealthiest taxpayers are usually reduced to a much larger degree than lower and middle class taxpayers.]

4. A tax reform that includes wholesale, immediate repeal of a significant portion of tax preferences would significantly disrupt existing economic arrangements in ways that might be deemed unfair. Instead, some preferences might be only partially curtailed, and some cutbacks might phase in, possibly over an extended period of time. In addition, taxpayers would likely change their behavior to lessen the impact of these cutbacks. All of these “real world” effects would likely reduce, perhaps substantially, the revenue gains from cutting tax preferences.

[Ed note: For example, if the charitable contribution deduction were to disappear on January 1, 2013, human nature would dictate that people would give less to charity in 2013, reducing the value of the eliminated deduction.]

The Center then examines whether the base can be broadened enough to offset the revenue caused by the rate cuts by comparing a proposed tax regime with a top rate of 28% with LTCG and dividends continuing to be taxed at 15%, titled “Current Policy with Reduced Rates,” with two different baselines:

1. One where the current law continues (maximum rate 35%/LTCG rate of 15%), titled “Current Policy,” and alternatively

2. One where the Bush tax cuts expire (maximum rate 39.6%/LTCG rate of 20%), titled “Current Law.”

The Center determines that under each alternative, the individual income tax revenue expected to be generated during 2015 is as follows:

Current Policy with Reduced Rates: $1.0 trillion

Current Policy: $1.3 trillion

Current Law: $1.7 trillion

[Ed note: This would seem to indicate that Romney’s plan would cause a reduction of $0.7 trillion in revenue as compared to the revenue generated should the Bush tax cuts expire, and a $0.3 trillion reduction in revenue over current policy. However, the Tax Policy Center’s analysis does not incorporate the fact that Romney would eliminate the tax on interest, dividends, and capital gains for those earning less than $200,000, a factor that would likely widen this disparity greatly.]

Making Up the Lost Revenue When Compared to Current Policy

The Center next determines that in order to offset the $0.3 trillion in revenue from a Current Policy baseline by cutting the rates, 72% of the following deductions would have to go:

  • Mortgage interest,
  • Charitable contributions,
  • State and local taxes,
  • Medical expenses,
  • All above-the-line deductions,
  • Exclusion for employer provided health insurance,
  • Education, energy, and other credits expect those related to children and low-income families,
  • The exclusion for income earned abroad.

Of course, 72% of each deduction wouldn’t have to go, but some combination of these expenses must be eliminated so that 72% of the benefit under Current Policy is eliminated. Either way, that’s a damn lengthy list with some high profile deductions on the chopping block. Take even one of the deductions in the group off the table, of course, and the percentage of the remaining deductions that have to be eliminated skyrockets.

Predictably, cutting the rates by 20% compared to current policy and eliminating 72% of these deductions would actually serve to decrease the net tax burden of the wealthiest 20%, while increasing the tax burden of the remaining 80%. Because this country has long prided itself on having a progressive tax system, this would be a tough pill for 80% of Americans to swallow.

Making Up the Lost Revenue When Compared to Current Law

Things get much more daunting, however, when the Center takes on the task of making up the $0.7 trillion in lost 2015 revenue caused by reducing the rates when compared with Current Law. To gain that much back in base broadening, 75% of the following preferences would have to be eliminated in addition to 100% of those listed previously:

  • The special 20% capital gains rate that would apply under current law
  • The deduction or exclusion of contributions to retirement accounts
  • The exclusion of investment income accrued in retirement accounts
  • The exclusion of interest on tax-exempt bonds.

Summary

I’m no genius, but it would appear to me that reducing the current tax rates by 20% while maintaining revenue neutrality is next to impossible. In a country where the preferential tax treatment afforded private equity fund managers continues to exist for no justifiable reason other than the significant support it garners from deep pocketed lobbyists, it is absolutely inconceivable to me that any president could be expected to push through so many high-profile tax preferences when each presents its own endless string of powerful supporters. And even if he could, unless the resulting tax distribution maintains its current progressivity, it’s going to be a very tough sell in this era of budding “class warfare.”

Of course, those guys at the Tax Policy Center are geniuses, so why not get their take on what they found:

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.

Read the entire paper here.

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In the not-too-distant future, it’s entirely possible that jet packs will replace Segways as America’s preferred mode of personal travel, online dating will create matches so perfect as to eliminate the thrill of romantic conquest, and Republicans will rule the White House, Senate, and House of Representatives.

Martin Sullivan, who writes about tax as well as anyone, takes on the final possibility and reaches a surprising, but completely accurate, conclusion: even if Mitt Romney wins the presidential election this November and Republicans keep the House and retake the Senate, Romney’s proposed sweeping tax cuts are unlikely to become law.

And why not?

Because as we discussed here, tax cuts come at the price of reduced revenue, and given the current and budgeted deficit, lost revenue is something America can ill afford at the moment.

As a reminder, Romney is proposing to extend the Bush tax cuts, while also tacking on a 20% across-the-board reduction to each marginal rate. In addition, he would eliminate the tax on interest, dividends and capital gains for taxpayers earnings less than $200,000, eliminate the estate tax and the AMT, and cut the corporate rate to 25%.

Even if Democrats continue to control the Senate, Romney would be able to circumvent having his proposals blocked in the Senate by presenting them as “budget reconciliation bills,” essentially giving Romney carte blanche to enact any desired tax legislation.

But as Sullivan posits, Romney’s cuts are unlikely to become law due to their staggering price tag: $480 billion in lost revenue in 2015 alone. To enact his proposals without adding to the deficit, Romney would have to generate tax revenue elsewhere. To that end, he has privately disclosed his desire to broaden the tax base by eliminating some popular deductions, but Romney would have to do away with all of the popular deductions listed below, and many more, to cover the cost of his cuts. These deductions represent a mix of those backed by special interest groups (the mortgage deduction), and those that promote philanthropy (the charitable contribution deduction.)  As a result, as Sullivan points out, “there is nothing in history to suggest that this is even a remote political possibility.”

Table 1. Official Revenue Estimates of Major Tax Expenditures

Tax Expenditure Fiscal 2015

Deduction for mortgage interest $113 billion
Charitable deduction $57 billion
Deduction for state and local taxes $85 billion
Exclusion for employer-provided health benefits $176 billion

Source: Joint Committee on Taxation, ‘‘Estimates of Federal Tax Expenditures for Fiscal Years 2011-2015,’’ Jan. 17, 2012, Doc 2012-894, 2012 TNT 11-21.

Sullivan goes on to nicely summarize the reality of our current economic morass and its impact on tax policy:

And that means that even if Romney wins and Republicans are running Congress, it is unlikely Washington will go on a tax cutting frenzy. Republicans may be unconstrained by Democrats, but they will be constrained by themselves. Basebroadening tax reform is not a battle of partisan politics but of special interest politics. And special interests will still be alive and well after a Republican sweep. If the Republicans try anything too gimmicky with how they score the tax cuts, alarm bells will sound in the bond market — something a president with close ties to Wall Street is unlikely to tolerate.

No doubt there will be spending cuts in social programs, but one must believe most of the savings will be devoted to deficit reduction. This is not 1981. This is not 2001. The next president, regardless of whether it is Obama or Romney, must put federal finances on a sustainable path. It is hard to see how a President Romney could propose a plan that significantly cuts taxes. If his plan must be revenue neutral, or close to it, the amount of rate reduction it can achieve will be severely limited.

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Super Tuesday is upon us, and while today’s Republican primaries don’t present the same opportunity for glorious Patriots’ choke jobs or unintentional nipple slips as Super Sunday, it does play a slightly larger role in determining the fate of the free world. So there’s that.

Today’s elections will go a long way towards deciding who will square off against President Obama in November, but don’t be fooled into thinking the Democrats are kicking back and watching the battle unfold with popcorn in hand. Rather, Senate Democratic leaders have been preparing a proposal to end the Bush tax cuts for the nation’s wealthy that, contrary to conventional wisdom, could be voted on prior to the November elections.

As a reminder, the Bush tax cuts — which reduced individual tax rates while also cutting the long-term capital gain rate from 20% to 15% and the top tax on qualified dividends from 39.6% from 15% — are set to expire at the end of 2012. This isn’t unchartered territory; President Obama was faced with a similar situation in late 2010, when the tax cuts were originally slated to expire.

At that time, the president opposed an extension of the cuts, but only for those earning more than $250,000.[i]The lower rates would remain in effect for those below that threshold.  The Democratic party was not united on this front, however, as many officials were facing re-election, and were loathe to anger some of their more influential constituents by approving a tax increase on the wealthy.

The Democrats chose not to push the issue prior to the elections, and by the time the smoke had cleared in November, they had lost their House majority. A stalemate ensued, and rather than risk the Bush tax cuts expiring for all taxpayers, the president agreed to extend the cuts through 2012.

It has widely been accepted that any vote on the Bush tax cuts would have to wait until after the November election. That may not be the case, however. From Bloomberg:

Senate Democrats are considering a debate on ending the George W. Bush-era tax cuts for top earners before the November election because they think they’re in a stronger position than in 2010, Senator Charles Schumer said. That is one of the things we’re looking at very carefully,” Schumer told reporters Feb. 28. “I think that the public is on our side.”

Democrats believe allowing the cuts to expire for those earning more than $250,000 is a matter of fairness; Republicans, to the contrary, argue that raising the top rates would harm small business owners. Many businesses are operated as S corporations and partnerships, where the taxable income is not taxed at the entity level, but rather at the individual level at the owners’ tax rates. If the individual tax rate rises, so does the owner’s “business” tax obligation.

With Senate Democrats defending 23 seats this November, it may be in the best interest of those anticipating heated elections to pursue a vote on the cuts sooner rather than later:  

Democrats in competitive races, such as [Senator Claire] McCaskill, said they would welcome the chance to vote on extending tax cuts only for the middle class. “It’s a great idea,” she said in a March 1 interview. “It’s important that the people in my state know whose side I’m on.”

I’m still fairly certain that the fate of the Bush tax cuts won’t ultimately be determined until a lame duck session at the end of 2012, but this discussion gives me at least a glimmer of hope that we won’t be left with hanging without 2013 tax rates until the wee hours of New Years Eve.


[i] Essentially, for those taxpayers, the top individual rates would revert back to 36% and 39.6% from the current rates of 33% and 35%.

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