Oct. 18 (Bloomberg) -- Mitt Romney says his tax plan adds up. President Barack Obama says it doesn’t. They don’t even agree on what “add up” means.
Romney’s proposed tax cuts create a $5 trillion hole in the U.S. budget, which he says would be filled by curtailing tax breaks and by assuming the tax cuts will spur economic growth. Obama says that Republican assumption simply means a bigger budget deficit.
The result Romney implies -- that rate cuts would generate jobs and build tax revenue at the same time -- may not mesh with the reality. Even advocates of Romney’s small-government policies say the growth effects would be long term and wouldn’t be felt in full for much of a Romney presidency.
“It would be a gradual process,” said Alan Viard, a resident scholar at the American Enterprise Institute in Washington, which favors smaller government. He urges a cautious approach when assuming how much of the tax cuts’ cost would be covered by growth.
The candidates’ quarrel over the basic rules of budget arithmetic makes the tax debate a bewildering set of claims and counterclaims that can’t be easily reconciled.
Romney and his allies say common sense, backed by solid economic theory, dictates that a simpler tax code with fewer decision-distorting incentives would encourage growth in the gross domestic product, generating more investment and thus more tax revenue.
‘Overstated the Cost’
“If one of the purposes of tax changes is to get the economy growing again, and you don’t bother counting that effect, you’ve overstated the cost of the tax cut,” says Stephen Entin, a senior fellow at the Tax Foundation, a Washington group that favors a simpler tax code.
So when Romney says that his plan adds up, he is assuming that some of the revenue to pay for the proposed tax cuts comes from growth. When Obama says Romney’s plan doesn’t add up, he’s employing the math used by Congress, which doesn’t allow higher growth to cover the cost of tax cuts.
As with much of his plan, Romney hasn’t been specific about how much he would rely on revenue from growth. When Romney released his tax proposal in February, Glenn Hubbard, dean of Columbia University’s business school and the top Romney economic adviser, said the campaign would release “precise estimates later” of how much revenue would come from growth. The campaign hasn’t done so.
7 Million Jobs
“Governor Romney’s tax reform plan has been estimated to create 7 million new jobs and increase annual GDP growth by a half percentage point,” said Amanda Henneberg, a spokeswoman for the campaign. “More Americans working and a healthy, growing economy generate higher revenues for the government.”
Romney’s plan would cut individual income-tax rates by 20 percent, eliminate the estate tax and alternative minimum tax and reduce the corporate tax rate to 25 percent from 35 percent. The combination of those policies digs a $5 trillion hole in federal revenue over the next decade that Romney has pledged to fill.
Without specifying how, Romney says he will eliminate that gap while protecting tax breaks for savings and investment, and preventing middle-class taxpayers from shouldering more of the federal tax burden.
Obama, who wants to raise taxes for top earners and multinational corporations, has cast doubt on Romney’s ability to achieve his goals simultaneously. He warns that Romney’s insistence on rate cuts would mean a bigger deficit or higher taxes for the middle class.
“He claims his $5 trillion tax cut will create millions of new jobs and pay for themselves,” Obama said Oct. 17 in Mount Vernon, Iowa. “We have heard this pitch before. You know where we heard it? In the previous administration. We know it doesn’t work.”
Obama’s plan adds up over the next decade in the sense that higher taxes for top earners help him meet the goal of stabilizing government debt as a percentage of the economy. After that, he hasn’t explained what he would do to manage a growing deficit and whether it would require higher taxes for more than the top 2 percent of taxpayers.
Romney’s response to Obama’s criticism, in part, has been to point to projected economic growth, which has been part of his plan for covering the cost of tax cuts since he proposed them in February.
Assuming growth helps make it mathematically possible that Romney could design a plan that meets his objectives.
The nonpartisan Tax Policy Center found that, even with growth effects, Romney’s plan would fall $33 billion short of paying for itself in 2015. Romney allies objected and listed other changes they said were on the table -- such as ending the tax break for municipal bond interest -- that would erase the gap.
Under TPC’s standard, though, erasing that gap would require Romney to support proposals he hasn’t offered or has suggested he wouldn’t accept, such as eliminating the charitable deduction once a household’s annual income reaches $200,000.
The back-and-forth between the campaigns about what’s arithmetically possible obscures the questions about how much growth Romney’s proposal might generate and whether he should be able to take credit within his plan.
In Washington budget circles, that’s called dynamic scoring, and it has been the subject of a decades-long debate between the parties. Republicans have been unable to change the rules used in assessing legislation to reflect dynamic scoring.
Precisely estimating the macroeconomic effect of tax cuts requires assumptions about the capacity of the economy, the deficit posture of the government and the probable responses by the Federal Reserve.
For example, extending the tax cuts for two years at the end of 2010 cost the U.S. government $858 billion in forgone revenue over 10 years, according to the nonpartisan Joint Committee on Taxation. Depending upon assumptions as to whether the tax cuts would be accompanied by spending reductions and on possible Fed reaction, estimates of the extension’s cost ranged from $719 billion to $1.05 trillion.
Simply looking to the past isn’t easy, either. Democrats point to slower economic growth after the 2001 and 2003 tax cuts were enacted and faster growth after the 1993 tax increases. What they can’t know is what would have happened in the absence of those policies.
Those are among the reasons why Congress receives macroeconomic estimates of major tax changes and doesn’t include them in the official scores of policies.
The debate over the economic and revenue effects of tax cuts has raged for decades. Republicans, including vice presidential candidate Paul Ryan, often cite the marginal rate cuts under Presidents John F. Kennedy and Lyndon Johnson, which dropped the top rate to 70 percent from 91 percent. The current top rate is 35 percent, meaning the potential changes in work incentives from a reduction are much less now than they were then.
Lawrence Summers, the former Treasury Secretary and Obama adviser, described Romney’s tax plan last week as the “daughter of voodoo economics.”
The plan relies on studies, Summers said during a speech in Washington, which argue: “I don’t know the details of the plan, but it might be possible to have a plan that would create a lot of growth, and if we did, then we might not need that much more revenue.”
Summers’s comment about “voodoo economics” referred to former President George H.W. Bush’s criticism in 1980 of the proposals of Ronald Reagan, his rival for the presidential nomination who later selected Bush as vice president. Reagan campaigned on tax cuts and enacted them in 1981. In some instances, Reagan and Bush both supported tax increases to combat the deficit.
Congressional estimates consider some economic effects of tax cuts. If Congress improves savings incentives, the scorekeepers assume that people save more. If Congress limits deductions, they assume people will take fewer deductions. The scorekeepers, though, don’t assume that a change will increase the size of the economy.
“To be sure, there is a lot of disagreement on this issue among professional economists,” Harvey Rosen, a Princeton University economist and Romney adviser, wrote in his assessment of Romney’s plan. “But that is not sufficient cause to assume that the right answer is exactly zero.”
Romney allies have offered several estimates. John Diamond, an economist at Rice University in Houston, wrote that Romney’s plan would increase GDP by 5.4 percent by the end of a decade, compared with current projections. Rosen said 3 percent would be a “reasonable” estimate. Entin and the Tax Foundation projected a 7.4 percent increase after a five to 10-year adjustment period.
Those studies have some limits, including the fact that they don’t have a detailed plan from Romney to consider. The Tax Foundation’s initial study didn’t include any of the economic drag caused by the limits on deductions.
Diamond uses a model that assumes full employment, Viard said.
“If there’s insufficient demand for workers and there’s still excess unemployment, I’m not sure how much the additional willingness of people to work will help,” said Alan Auerbach, an economics professor at the University of California, Berkeley.
Good for Growth
There’s also an important distinction between the short run and the long run. Economists agree that eventually a more efficient tax code with fewer distortions would be good for growth.
Romney’s tax cuts aren’t all equal either, a point the campaign made when it released the plan. In February, Hubbard said he expected the corporate rate cut to have larger economic effects, because capital is more responsive to tax changes than labor.
Rather than relying on growth to offset the tax cuts, Auerbach said, the more prudent course would be to pay for the entire tax cut and let revenue from growth reduce future budget deficits.
“If it works the way we think it’s going to work, then this will help us achieve an objective,” Auerbach said.
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