How Romney’s Tax Cut Works

Much is made of Mitt Romney’s 20% across the board tax cut. To many voters, this sounds like a panacea, the best of all worlds. Romney claims that his tax cuts will be revenue neutral; that he wont cut taxes on the wealthy, and that cuts to deductions will be at the high-end. Analysts have made much of the fact that Romney has not flushed out the details of his plan. He has, but people are just not paying attention to the details that he does come out with periodically.

The plan will work mathematically, and be revenue neutral, but who will pay the piper is still an open question. Again, listening to what Romney is saying, it is fairly clear as to who the losers might be. I have come up with a basic calculation taking into account some of what Romney has allowed to slip during his campaign and the debates. This is how I believe the plan is likely to take shape.

Firstly, on the 20% tax cut. Romney claims that he wants a 20% tax cut across the board. What this really means is that he wants a 20% tax “rate” cut across the board. This is not the same thing as a tax cut. If that were the case, the plan could not possibly be revenue neutral. We use a progressive tax system in which all income above certain cut-off points is taxed at a higher rate.

Currently, the tax brackets are 10%, 15%, 25%, 28%, 33%, and 35%. A 20% across the board cut will mean tax brackets of about 8%, 12%, 20%, 22%, 26%, and 28%.

Government revenues in 2013 will be about $2.9 trillion. Romney has indicated a 20% across the board tax rate cut. Whether that will include such things as excise cuties remains to be seen. It also remains to be seen whether he will order a cut in Social Security and other payroll taxes. Social Security and Payroll tax revenue amounts to some $969Bn of the total. If we assume that half of the Payroll tax will have its rates cut 20%, what we are left with is $484Bn in tax cuts. Over a decade, that amounts to a $4.8 trillion tax cut, which is the figure that Obama talks about.

This means that Romney will have to find almost $5 trillion in savings before the tax cut is revenue neutral, without considering the deficit in receipts, which amounts to over $1 trillion. In addition, Romney proposed an increase of $2 trillion in defense spending, meaning that he will have to find at least $7 trillion in revenue before tackling the deficit.

There are a number of deductions that he could target to pay for his cut in rates. The largest is the amount of revenue lost by the treasury to the Health Insurance deduction. This allows individuals to deduct the cost of purchasing health insurance. Treasury loses $132Bn to this deduction each year. If individuals were denied this deduction, they will end up paying much more for their health insurance. In addition, Romney’s elimination of The American Care Act (Obamacare) will mean that poorer taxpayers will incur an added medical burden. This deduction will have to go to make the tax plan revenue neutral.

The mortgage interest deduction is possibly the next to go. The deduction is generally used by wealthier taxpayers, those earning over $100k, since the interest on smaller loans is insufficient to allow taxpayers to itemize deductions. The deduction costs the Treasury about $97Bn per year. This deduction is only available to taxpayers with a mortgage, which generally excludes the poor and lower Middle Class. It is unlikely that Romney will be willing to take this popular deduction away from mostly wealthy taxpayers.

The capital gains deduction costs the Treasury about $39 billion per year. It is highly unlikely that Romney will eliminate this deduction given his stated position on capital gains. If anything, he is likely to reduce the tax paid on capital gains even further, in line with conservative thinking. He has indicated that for people with under $100k in capital gains or dividends, they will pay no effective tax. That will significantly increase the cost to the Treasury.

The Defined Benefit and Defined Contribution Pension deduction currently costs the treasury $103Bn. It will be politically tenuous to eliminate these two deductions, but it could happen, and will have to happen to balance the books.

The earned income tax credit is the deduction that the conservative right detests most. This deduction allows the very poorest taxpayers to receive a refund from the Revenue Service based on a formula, even if they have not paid federal income tax. This deduction provides a relief to the very poorest among us, and while it is the charitable thing to do, Romney is unlikely to keep it, increasing the tax burden on the poor. It costs about $53Bn each year.

The deduction for paying state and local taxes is likely to go, increasing revenues by $47Bn.

The charitable deduction is questionable and could well be curtailed. It costs about $36Bn per year.

Social Security and Railroad benefits, for which taxpayers paid their entire lives, are generally immune from taxation except under certain circumstances. This costs the Treasury some 24Bn per year. Romney is quite likely to tax these benefits in the name of “broadening the base”. This will put an added burden on the elderly when they are most vulnerable.

The total cost of these eight deductions to Treasury is $542Bn each year, or $5.42 Trillion over a decade, which will handily pay for the Romney tax cuts. However, the capital gains deduction is likely to stay, which reduces the total to $503Bn, and some of the other deductions will probably remain as they are. I believe that there is a more plausible scenario than merely eliminating deductions, and it goes as follows.

Romney recently added another twist to his plan. He says that he wants to add a deduction “bucket” to the tax code. Currently, people can choose whether to itemize or take the standard deduction. Most tax returns are not itemized because most people do not have sufficient deductions to exceed the Standard Deduction plus individual exemptions. More than 75% of returns use the Standard Deduction, most of whom do not have sufficient deductions to itemize.

Romney has mentioned a figure of $17,000 or $25,000 as his “bucket”. The implication is that he wants to eliminate the Standard Deduction entirely, otherwise, why does he propose a deduction bucket? For those people who do not currently itemize, most have very few deductions. Many poorer taxpayers pay rent and could not take the mortgage deduction, cannot afford health insurance and donate little to charity. For these people, the lack of deductions will amount to a massive tax increase. For people who itemize, little will change, depending on the size of the deduction bucket.

Consider a married person with two children earning $30,000 per year. He can deduct ($11,900 Standard Deduction + $3,800 per dependent), or $27,100 in total deductions. If we include his contributions to Social Security and Medicare, his taxable income is $170. At current rates, he currently pays $17 in income tax.

If the Standard Deduction and dependent deductions are eliminated, the taxpayer will be taxed on ($30,000 – $2,730 in payroll taxes), he will owe $3220 ($2576 with Romney’s rates) in tax, an increase in taxes of $3203. Without a mortgage, health insurance and other deductions, this taxpayer will be facing an effective 10.7% (8.5%) tax rate. Currently his rate, excluding payroll taxes, is 0.05%.

A similar calculation with someone earning $70,000 per year will yield the following; ($70,000 – ($3,903 in payroll tax + $27,100 standard deductions), producing $38,996 in taxable income. This results in $4,979 in tax, a 7.1% tax rate. If the Standard deduction and dependent exemption is eliminated, the tax will be $8,674, a 12.4% rate.

We should also remember that payroll taxes like Social Security and Medicare are deducted from income at the rate of 7.65% and 1.45% respectively. This means that for someone earning $30,000, his tax rate is 9.2% under current rates and 17% with Romney’s plan, a $3,200 increase. If we add in the employers portion, since the employee does ultimately pay this tax, his rate is 18% currently ($5,477) and  26.7% ($8,036) under Romney’s plan (new rates), a $2,500 difference.

For someone earning $70,000, the figures are; 7% tax ($4979), 12% with SSI ($8883) and 18% ($12,787) with employers portion. Under Romney’s plan, it will be 10% tax ($6939), 19% ($13,309) with payroll tax, and 28% ($19,679) with employers portion. Total tax will rise $6,800 with Romney’s plan.

This is how Romney plans to finance his tax plan. It will involve a massive increase in low-income taxpayers, despite the reduced rates. The “bucket” that he mentions will only kick in for those people who are able to avail themselves of itemized deductions. If you do not have health insurance, a mortgage, or capital gains, you pay the full tax. For people with a larger mortgage, the effective tax will be lower, but not by much.

Considering that 75% of taxpayers do not itemize, around 90m Americans use the Standard Deduction. If that is eliminated, revenues will be starkly higher. Without any deductions, taxable income will increase by a combined $1.5 trillion per year (based on two people per family). If those taxpayers used half of the standard deduction for actual deductions on average, the increase in taxable income be $7.5 trillion over a decade, sufficient to help cover the tax rate cuts. Since additional income is taxed at the top marginal rate, a taxpayer in the 28% bracket will pay an effective 28% on the lost deduction. Even at a 10% rate, the treasury will receive an extra 750Bn over ten years.

It is quite clear from this plan that Romney plans to begin the task of implementing a flat tax, putting far more of the burden on the very poor and handing huge tax cuts to the wealthy, those with large mortgages, Cadillac health insurance, and capital gains. The wealthy can then hide income in capital gains instruments, larger homes and inflated medical insurance, and pay an even lower effective tax rate than they do now. The extreme right is salivating over the thought of giving the wealthy even more and squeezing the Middle Class. Removing the Earned Income Tax Credit for poorer taxpayers will realize a long dream and cripple the poor.

Also, little is said about his plan to cut corporate taxes. Since their deductions are entirely separate from individual deductions, they will probably remain as they are. However, they will still receive the 20% across the board tax cut, sharply lowering their tax bill and putting more money into the hands of CEO’s and wealthy investors.

Instead of an even more progressive tax that will force the wealthy to contribute more to the people who create their wealth, Romney’s plan increases the burden on the poor. A fallacious attempt to claim that the plan will increase economic activity does not live up to scrutiny.  The poor and Middle Class will end up paying a lot more, inducing a massive decrease in spending and income for rent, food, education and transport. This will lead to more layoffs by corporations, and an attendant decrease in economic activity. The result will be economically and politically disastrous for the United States.

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