The Real Reason Romney’s Tax Math Doesn't Add Up

Mitt Romney’s tax plan has three key planks. He cuts personal income tax rates by 20 percent across the board; he eliminates deductions, exclusions and credits so that the deficit does not grow; and he doesn’t make the tax code any less progressive. Unfortunately, as the Tax Policy Center has shown, only two of these planks can co-exist.

Conservatives have reacted aggressively against the TPC report. It seems that Mitt’s plan should be viable: If you cut tax rates proportionally across the board, and eliminate tax deductions proportionally, it seems progressivity should be unchanged. In fact, if you eliminate tax breaks starting with the wealthy, as Romney says he would, it seems he should be able to make the tax code even more progressive.

The idea is intuitive, but wrong. And it’s wrong because of something people don’t realize: The tax preferences that exist today overwhelmingly benefit people with lower and middle incomes, not the wealthy. While tax rate cuts reduce income tax burdens proportionally, as TPC notes, there aren't enough tax preferences for wealthy people to offset Romney's cuts at the top.

To understand this, we can look at the IRS Statistics of Income report for 2009, the most recent year available. Tax returns reporting less than $200,000 of adjusted gross income (AGI) accounted for a total AGI of $5.86 trillion, and taxable income of $3.24 trillion. That is, deductions and exemptions amounted to 45 percent of adjusted gross income for people making under $200,000.

Tax returns with more than $200,000 of AGI (the highest-earning 2.8 percent of filers) had a total of $1.96 trillion in AGI and $1.62 trillion in taxable income. For this high-income group, deductions and exemptions were just 18 percent of adjusted gross income.

Put another way, filers with over $200,000 of income earned 26 percent of all personal income in 2009, but received only 12 percent of tax exemptions and deductions.

If you think about it, this makes sense: Everyone gets the same $3,800 personal exemption ($3,650 in 2009). That amount shrinks as a share of your income the wealthier you get. Other deductions grow with income, but generally not as fast as your income; wealthier people have bigger mortgages, but you can only use so much real estate. The Alternative Minimum Tax also eats away at the value of deductions and exemptions for some people with high incomes.

These statistics actually understate the extent to which tax preferences (at least those put on the table by Romney) favor low- and middle-income Americans. The statistics don’t include the tax exclusion for employer-provided health insurance, which shields a larger share of income from tax for middle-income people than for upper-income people. And they don’t account for the value of tax credits, which disproportionately benefit the poor and middle class.

There is a large tax preference for the wealthy that does not show up in these statistics: the preferential tax rate on capital gain on dividend income. But Romney has specifically taken that off the table as a means of raising revenue. (For good reason, in my opinion, but it makes the rest of his math impossible.)

That’s why Romney can't find enough tax preferences to offset his across-the- board rate cut -- unless he raises taxes on earners making under $200,000. That’s not to say we shouldn’t reduce tax preferences. It is to say that we shouldn't look to their elimination as a way to cut tax rates by 20 percent.

Original Article
Source: bloomberg
Author: Josh Barro