Back of the Envelope Debate Math

I'm going to focus on the presidential race in this post.   Back to NH District 1 soon.

Mitt Romney's tax plan is going to be a big subject in the presidential debate coming tomorrow night.   What deductions will he have to cut if he cuts rates by 20% ?    Here's my back of the envelope debate math.  

I'll try to keep it simple. I'm going to express everything in fraction of GDP because it's easier to get your head around that than trillions of dollars.

Mitt Romney's plan is a 20% across the board cut in tax rates. Mitt says it will be revenue neutral. This means tax deductions must be reduced if total tax revenue is to stay the same under the lower rates. If you raise taxable income by reducing deductions you can collect the same total amount of tax with lower rates. That's the plan. With me so far?


Up to here, I don't think Mitt would disagree with how I've described his plan.   Why it's supposed to work I'm less sure.  Somehow the magic of lower rates is supposed to create jobs even though the total tax burden is the same. It's just paid by different people. For now, let's skip the question as to whether that would actually create jobs and focus on how to make the numbers add up.


Federal income tax is about 9% of GDP (this excludes payroll taxes, and includes 7.5% personal income tax and 1.5% corporate income tax).  20% of that is 1.8% of GDP. So if Mitt's plan is going to be revenue neutral, it needs to reduce deductions by 1.8% of GDP.

Actually, Mitt's plan also eliminates the estate tax and the AMT and lowers corporate tax.    The number being tossed around is $5T over 10 years, about 3% of GDP.   Let's go with 2.5% on the back of the envelope.

Here's how much each deduction costs the treasury, biggest on down, as a percentage of GDP.  I'm using the word deduction loosely here to refer to all tax expenditures.

Cost(%GDP) Deduction

1.8% Employer Healthcare Deduction
1.1% Retirement contributions not taxable
0.8% Mortgage Interest
0.5% Reduced rate on dividends & capital gains
0.3% Capital Gain Exclusion at Death
0.3% State and Local Tax
0.3% Charity
0.3% Earned Income Tax Credit
0.2% Untaxed Retirement Benefits (incl Social Security)

0.1% Child Tax Credit

1.0% Other

That's about it for the substantial ones. The plan requires you cut 2.5 points out of the these deductions listed.  They add up to about 6.7  points, 6.7% of GDP. So Mitt's plan is to cut about one third of deductions, each of which some people have grown pretty attached to. There's no other way. Mr. Romney wants all the votes he can get, so he does not want to piss off any of those people. That's why he can't possibly give details of his plan in the debate. If he does start to list things he wont touch ("the mortgage deduction is sacred", say) you can use this handy table to figure out what's left -- that's what he actually plans to cut.

The rest of this was written in the middle of the night and may ramble.   Feel free to stop here.

[Sanity check.   GDP is around $15.5 trillion.   15.5*.09 = $1.4T income tax.  20% is $0.3T, the revenue lost from reducing rates.   Over 10 years that's $3T.   The number you hear for the amount of deductions to be cut to make Romney's plan revenue neutral is $5T.   I think there's more in Mitt's plan than the 20% rate cut that goes into that number.  Maybe the AMT, Estate Tax and corporate tax cuts.    The real amount may be higher, up to 3.0% of GDP]

Actually, I've heard it proposed that Mitt would eliminate all dividend & capital gains taxes.  This doesn't seem to be part of his current proposal, but let's see what that would do to the other deductions.  Those taxes collect around 2% of GDP. So we could cross the cap gain stuff off my list, leaving 6% of GDP available to cut. We'd then have to cut 4.5% of GDP (2.5+2) to stay revenue neutral. In other words, a 20% across the board income tax rate cut coupled with eliminated tax of dividends and capital gains would require 75% of every other tax deduction to be cut in order to be revenue neutral.

Here's news that Mitt is proposing reducing the mortgage deduction.

News just out that Mitt has floated capping total itemized deductions at $17,000.   That seems a pretty progressive proposal for a guy like Mitt.  It's definitely the higher incomes that have deductions greater than $17,000.  

I understand that Mitt current plan does not touch the rate on investment income beyond repealing Obamacare.   His taxes, and all those that make money from dividends and capital gains, will remain largely unchanged.

But it's different if you make a wage.  Your rate goes down by 20% but you lose deductions.  In New York City I think you pay around 12% state and city income tax.   So just the state and city tax on $140,000 would eat up your entire deduction.   That's not really that high an income for a New York couple.   You save .20*$27K= $5,400 from the rate cut.   That's about what your mortgage deduction was probably worth.  You don't get to deduct any additional state and city tax. No charitable deductions.

So, Mitt's plan a hurts the people in the high tax places more.   This is a good choice for Mitt -- he's probably not going to win in New York, New Jersey, Connecticut, Massachusetts or Maryland anyway.

For very high wages with state tax.  If your wage is w, your state tax rate s and the top marginal federal bracket is f, your state tax deduction is worth d=s*w*f.   Under the Romney plan, you save t=.20*f*w.   The benefit to the taxpayer of Mitt's plan = t-s = (.2-s)*f*w.   f*w is the (approximate) tax you owe.  (.2-s)*f*w is the amount you save under Mitt's plan.  Since all state taxes are less than 20%, .2-s will be positive, and the high wage earner saves money under Mitt's plan  (not counting other deductions they'd lose).   The less state tax you paid before, the more you save.

OK, I've really gone off the deep end here.  See you after the debate.


Thursday, October 4.   Debate Postscript.

I'll admit I'm a bit depressed after the debate. Democrats are just going to have to buck up, get tough and work harder now. Rather than wallowing I thought I'd come up with what I would have said to Mitt about his tax plan. Maybe that is wallowing. But it's constructive too because there's still time to say it.

It was a very wonky debate, so here's my rather wonky take on what I think the president should have said about Mitt's plan. 

Let's focus on the top 5% of personal federal income tax returns. That's about 6 million families with the highest income. For over a decade, they've all always earned above 250,000 a year every year. Sometimes much more. Their average income is over half a million dollars a year. They pay about 16% in personal income tax. This works out to about 500 billion dollars a year in personal income taxes from these folks. On behalf of the United States of America, I want to thank them for that. That is a real contribution to building our country.

Mitt, your 20% rate cut by itself reduces their tax bill by 100 billion dollars a year. Currently these folks use tax expenditures, meaning they take deductions and exemptions, that in total reduce their taxable income by 17%. So you're going to have to eliminate all their deductions. You have to take away their home mortgage deductions, take away their state and local tax exemptions, take away their charitable contribution deductions, and all the rest. And you'll still collect 3% less of their income, about 15 billion dollars less. And when you back out expenditures for investment income and gains, which you've said you wouldn't touch, it's more like 30 billion dollars a year less your plan collects from these folks. You're going to have to get that 30 billion from lower income folks if you want to make your plan revenue neutral. It's just math.

References

http://www.cbo.gov/publication/43373
http://www.urban.org/UploadedPDF/412495-Distribution-of-Tax-Expenditures.pdf
http://www.taxpolicycenter.org/UploadedPDF/1001234_tax_expenditures.pdf