The president wants to allow the Bush tax cuts on those making more than $250,000 ($200,000 if single) to expire but to extend the Bush tax cuts for those making less than $250,000. When examined along with his other tax policy proposals, his plan will reduce revenues by almost $3 trillion and leave in place a hopelessly complex, inefficient, inequitable, and growth hampering tax system. With the exception of raising tax rates on high-income taxpayers, his plan is simply an extension of the fiscal policies under the Bush administration – deficit-financed tax and spending policies. Unfortunately, the president’s policies will act to mitigate any increase in economic growth in the medium and long term, and thus accentuate the burden of increased debt obligations on future generations.
On the other hand, Romney’s tax reform plan is similar to the one proposed by the president’s debt commission. The commission envisioned tax reform that would achieve four basic goals: (1) lower tax rates and broaden the tax base, (2) reduce the deficit, (3) maintain the progressivity of the tax code, and (4) increase job creation and America’s productive capacity. One of the main policy tools to accomplish this is an across-the-board cut in income tax rates to 12, 22, and 28 percent. This represents at least a 20 percent reduction from the tax rates we’re facing in 2013, and is similar to the Romney proposal to reduce tax rates by 20 percent. In addition, the debt commission stated that the top rates should not exceed 29 percent, a far cry from the 45 percent capital income tax rates under the President’s proposed policies.
The commission’s report also included a number of options on how to reduce and reform tax expenditures (spending through the tax system) to maintain progressivity and raise the needed revenue to fund the proposal. The commission’s illustrative proposal would maintain support for low-income workers and families (e.g., the child tax credit and earned income tax credit) and reform and maintain the mortgage interest deduction, the deduction for employer provided health care, the charitable deduction, and retirement savings and pension deductions. Not only would these reductions pay for the tax cut — it would allow the government to dedicate $80 billion to deficit reduction in 2015 and $180 billion to deficit reduction in 2020. The debt commission’s illustrative plan also would maintain the progressivity of the current system.
So, to review: The president’s commission proposed to cut tax rates by at least 20 percent, to raise revenue by broadening the base and reducing tax expenditures, and to do so in a manner that maintains progressivity — similar to Romney’s tax plan.
There are a few differences worth mentioning. First, the debt commission proposed reducing the deficit, while Romney has stated that his reform would be revenue neutral. Second, Romney proposed reducing the corporate rate to 25 percent, while the president’s commission proposed lowering the corporate rate to 28 percent. Third, the commission proposed taxing capital income (dividends and capital gains) at ordinary income tax rates as opposed to the lower rates proposed by Romney. But these are not major differences, especially if the revenue-boosting effects of economic growth are taken into account.
And economic growth is exactly what we would get from tax reform like this. In my own work, I have calculated that the dynamic effects of a base-broadening, rate-reducing reform, similar to the Romney proposal, would be considerable, growing the size of the economy by up to 6 percent, and putting millions of Americans back to work. That along with other changes affecting higher income taxpayers would more than finance a reduction in capital income tax rates as well as additional debt reduction.
By comparison, the Congressional Budget Office predicts the president’s plan, which to a large extent would continue the Bush era policies, would reduce economic growth (and thus job creation) in the medium and long-term by as much as 2.2 percent, and would increase the deficit by at least another $2 trillion. In addition, an July 2012 E&Y study reported that the president’s plan to increase tax rates on high-income taxpayers would reduce economic growth by 1.3 percent, reduce employment by 0.5 percent, reduce investment by 2.4 percent, and reduce real after-tax wages by 1.8 percent.
Base-broadening, rate-reducing tax reform and the adoption of sustainable fiscal policies in the medium and long term are absolutely crucial to putting America on the path to prosperity once again.
Diamond is the Edward A. and Hermena Hancock Kelly Fellow in Public Finance at the James A. Baker III Institute for Public Policy at Rice University.