Romney's critics are right: His plan -- with 20% cuts to rates -- would have to raise taxes on the middle class. But if you tweak just that one number, his principles (lower rates, fewer loopholes) look very defensible.
Governor Romney is proposing a major tax reform plan with three main planks: cutting marginal tax rates across the board, not adding to the deficit, and maintaining the existing progressivity of the tax code. Both his critics and many non-partisan writers and economists argue that his plan will result in a middle class tax increase. But that's not the only possible outcome. A fair reading of the Romney campaign's recent public statements suggests that the governor will be able to satisfy all three planks. Here's why.
The Tax Policy Center (TPC) was the first to argue that these three goals cannot be achieved under Governor Romney's plan. Their analysis is quite straightforward. Let's walk through it now.
Under Mr. Romney's plan -- reducing individual income tax rates by 20 percent across the board; eliminating the AMT, the estate tax, and the high-income taxes associated with Obamacare; and eliminating taxes on interest, dividends, and capital gains for taxpayers with AGI less than $200,000 -- the federal treasury sees a reduction in 2015 of $360 billion relative to the amount of tax revenue it would receive under current policy.
In order to ensure that these tax cuts don't increase the size of the deficit, Mr. Romney needs to close some loopholes and eliminate some deductions. He has promised to maintain current tax rates on interest, dividends, and capital gains for rich households. So the TPC naturally assumes that tax provisions targeted at savings and investment are off the table.
This leaves popular expenditures like the mortgage interest deduction, the tax-free status of employer-provided healthcare, the deduction for charitable giving, and the EITC. Eliminating all loopholes and deductions not targeted at savings would generate $551 billion in additional tax revenue. But only $360 billion are needed, so only 65 percent of the $551 billion have to go.
So far the TPC has just laid out the facts. But here the TPC makes a heroic assumption which actually biases their results in favor of Romney: they allow for all tax expenditures to be eliminated from households earning more than $200,000 before eliminating any tax expenditures from households earning below that amount. (It's virtually certain that a President Romney won't propose the complete elimination of deductions for any one income group.) It turns out that eliminating all deductions for the rich isn't enough to ensure revenue neutrality. Tax expenditures for sub-$200,000 households must be cut by 58 percent in order to keep the deficit from increasing.
The TPC concludes that the combination of a 20 percent rate cut and maintaining revenue neutrality requires that Mr. Romney raise taxes on the middle class.
The TPC's analysis jives with common sense: The rich would see a larger financial benefit from a 20 percent rate cut than they receive from all current loopholes and deductions, so cutting rates and paying for it with base broadening will make them better off. Since the rich don't enjoy enough loopholes and deductions to pay for all the across-the-board rate cuts, and since the deficit can't increase, the middle class has to pick up the rest of the tab.
Various analysts and economists have looked at the TPC study and quibbled with the details. It is true that if you assume tax reform will increase economic growth or if you assume that some deductions can be eliminated which the TPC kept in place then you can get to deficit neutrality without a middle-class tax hike. But the heroic assumption made by the TPC is hard to overcome with tinkering.