Mitt Romney is calling for income- tax reform as part of his program to increase U.S. economic growth.
The Republican presidential candidate proposes to reduce all marginal tax rates by 20 percent; repeal the alternative minimum tax; limit the tax rate on dividends and capital gains to 15 percent; eliminate taxes on interest, dividends and capital gains for families whose incomes are less than $200,000; and broaden the tax base by reducing or eliminating various tax preferences. The Romney campaign has asserted that all this can be done in a way that raises the same amount of revenue as under the status quo -- and without increasing the tax burden on people whose incomes are low or moderate.
The Tax Policy Center, a project of the Brookings Institution and the Urban Institute, has challenged this assertion, arguing in a recent paper that it is mathematically impossible. The center contends that the Romney proposal would give a tax break to high-income families, requiring other families to pay more to make up for the lost revenue. This has set off a spirited debate, much of which has focused on the feasibility of eliminating various tax preferences.
One essential issue has been mostly absent in the debate, however, and that is the effect the Romney proposal could have on economic growth. This is an odd omission, because the primary motivation behind the proposal is to promote growth.
(Disclosure: I have signed a statement in support of Romney’s candidacy and have been contacted by his advisers from time to time but have no affiliation with the campaign.)
The Tax Policy Center model assumes that, regardless of their tax rates, people will work the same amount of time and will save and invest the same amount of money. It is important to note that this is the center’s usual approach; it hasn’t changed its standard operating procedure in order to make the Romney proposal look bad.
That doesn’t necessarily make their assumption a good one. When concerned citizens look at tables that purport to show the taxes that would be paid under someone’s tax proposal, they might reasonably expect to see, well, the taxes that would be paid under that proposal. By assuming that a change in the tax code would make no difference in the way people work or save, the Tax Policy Center’s analysis doesn’t tell concerned citizens what they want to know.
According to my own highly unscientific survey, even professional economists who aren’t aficionados of tax policy are surprised to learn that the numbers discussed in the news media are based on calculations that explicitly rule out any changes in labor supply or investment behavior. In the academic literature on tax policy, it is routine to include such behavioral effects.
The basic question that arises here is, how much would the Romney proposal increase growth? Both economic theory and historical experience suggest that, in any income tax system, lowering marginal rates and broadening the base enhance growth. However, no one knows for sure the precise magnitude of the effect. Economic behavior is very complicated, and let’s face it, economic forecasters haven’t exactly covered themselves in glory during the past few years. But it by no means follows that a zero response is the right answer.
In light of the uncertainty, it makes sense to consider several possibilities. In a recent study, I took this tack, including estimates for zero, three, five and seven percentage- point increases in income levels.
Here’s what I found: Assuming that current tax policy is the starting point, a modest 3 percent increase in incomes generated by the more efficient tax system would lead to about $14.7 billion in additional taxes from people whose incomes are $200,000 and above. Revenue is also increased by reducing the incentive to engage in various tax-avoidance activities (for example, buying municipal bonds, the interest on which isn’t taxed). Taking into account the effects of both growth and reduced tax avoidance, members of this income group would pay about $29 billion more in taxes.
In short, a proposal along the lines of the one Romney has suggested wouldn’t necessarily lower the tax burden on high earners. So moderate- and lower-income families wouldn’t need to pay more to keep total revenue from falling.
The crucial lesson is that higher rates of economic growth under Romney’s plan would be big enough to matter. To be sure, the actual extent to which a program of tax reform (and regulatory reform) would increase growth is controversial. But this should be debated, not ignored. The potential for economic growth should take center stage in the national conversation over tax policy.
Today’s highlights: the editors on how Congress has let companies shortchange pension funds and on the Obama administration’s trade dispute with China; Edward Glaeser on Obama’s missed chances for long-term economic reform; Adam Minter on China’s anti-Japanese riots; Ramesh Ponnuru on the makers versus takers election; Shikha Dalmia on why immigrants can’t save U.S. cities by themselves.
To contact the writer of this article: Harvey S. Rosen at HSR@Princeton.edu.
To contact the editor responsible for this article: Mary Duenwald at firstname.lastname@example.org.