Two days before the last night’s presidential debate, the Washington Post’s frenetic blogger Ezra Klein wrote that “Romney’s tax cuts cost $5 trillion over 10 years before his (unnamed) offsets. Extending the Bush tax cuts on income over $250,000 adds another $1 trillion. Then there’s the $2 trillion in new defense spending. So before Romney can cut the deficit by a dime, he has to come up with $8 trillion in offsets and savings for these plans.”
Obama echoed Klein’s remarks quite closely in the second debate, but the figures are pure fiction.
One part of the ruse, the $5 trillion tax cut, began by taking a crude one-year estimate from the Tax Policy Center (TPC) and erroneously multiplying it by ten. The original estimate, Klein explained, pretends that “in 2015, the Romney-Ryan rate reduction will reduce tax revenue by $480 billion compared to current policy. That’s the raw number, before you start arguing over behavioral responses or growth.” Yet we absolutely have to argue over immediate behavioral responses, reflected in what’s called “the elasticity of taxable income,” to come up with credible revenue estimates, even aside from economic growth.
Without taking taxpayer behavior into account, neither Klein nor the TPC can explain why revenues from individual income taxes were only 7.7 percent of GDP from 1951 to 1963, when dozens of tax rates ranged from 20 to 91 percent; or why such revenues were 8.1 percent from 1988 to 1990, when the top tax rate was 28 percent; or why they were 8 percent from 1993 to 1996, when the top rate was 39.9 percent. TPC-style “raw” estimates would have wrongly predicted that revenues would fall sharply after Kennedy and Reagan cut marginal tax rates by 22 percent and 23 percent respectively. And the same static methodology wrongly predicted that revenues would promptly rise as a share of GDP after top tax rates were increased in 1991 and 1993. In each case, the opposite happened.
Romney’s plan to cut the corporate tax rate to 25 percent also cannot be understood without, as Klein puts it, “arguing over behavioral responses or growth.” Karel Mertens of Cornell University and Morten O. Ravn of University College London find that “cuts in corporate taxes have no significant impact on revenues because of a very elastic response of the tax base.” Roger H. Gordon of the University of California, San Diego, in a 2004 paper with Korean economist Young Lee, found “a cut in the corporate tax rate by ten percentage points will raise the annual growth rate by one to two percentage points.” In other words, Romney’s lower corporate tax rate won’t cost the Treasury a dime, but will likely boost GDP growth by a percentage point or two. Who wants to argue or vote against that?
What about the alleged $2 trillion in “new defense spending”? This refers to Romney’s intent to allocate 4 percent of GDP to defense. Since the CBO projects nominal GDP will rise 59 percent from 2012 to 2022, it is arithmetically certain that 4 percent of GDP (or 3 percent) will involve a rising number of dollars over ten years. “That would add as much as $2.3 trillion to the defense budget over 10 years from projected 2013 spending levels,” wrote Carol Giacomo of the New York Times. But that is not an increase relative to what the CBO or Obama project for future defense spending, but merely a nominal increase compared with dollars spent in 2013. It is preposterous to call that “extra” defense spending.
Besides, changing the mix of spending priorities requires no extra revenue so long as Romney keeps his pledge (which Obama and Klein dutifully ignore) to get spending back to 20 percent of GDP by 2016. Compared with Obama’s 2013 budget plan, which keeps spending near 23 percent of GDP indefinitely, Romney is not proposing spending $2 trillion more, as Obama pretends, but $4.1 trillion less. Federal spending averaged 19.5 percent of GDP from 1995 to 2008, so 20 percent is scarcely unrealistic, even with a fifth of that going to defense.
What about the alleged $1 trillion for “extending the Bush tax cuts on income above $250,000”? That estimate is rounded up from page 203 of the Treasury’s Green Book — a rosy picture of the loot Obama might grab from his redistributive tax schemes in which incentives are unaffected by high tax rates. Raising the top two tax rates accounts for only $441.5 billion, however; the rest mainly comes from re-implementing deduction and exemption phaseouts for high-income taxpayers, policies known as “PEP” and “Pease.” When it comes to deductions, Romney’s plan to cap the dollar amount is a much bigger source of revenue than Obama’s (deductions average 23 percent of gross income), yet less discouraging at the margin, because earning more would not result in losing deductions.
The Obama-Klein team, feigning ignorance of Romney’s suggestion to cap deductions, speciously accuse him of forgoing revenue that, under Obama’s planned tax increases, comes from limiting deductions for those with high incomes. But Romney himself, like Warren Buffett, Bill Gates, and George Soros, stands to lose millions of dollars of charitable deductions each year from his own tax reform.
Klein almost gave this whole $8 trillion charade away by finding it “darkly hilarious” and “flatly untrue” for Romney to compare his tax reform with Simpson-Bowles. “The Simpson Bowles plan,” wrote Klein, “cut tax rates and lowered deductions and exemptions as a way to generate $2 trillion in new revenue. Romney doesn’t generate any new revenue.” Now wait a minute. How could Simpson-Bowles increase revenue by $2 trillion if the Romney plan, which sounds similar, would reduce revenue by $5 trillion? The lowest tax rate is a bit higher in Simpson-Bowles, 12 percent rather than 8 percent, but that could barely account for $1 trillion, much less a difference of $7 trillion. Simpson-Bowles would also raise the capital-gains-tax rate from 15 to 28 percent, but that can’t be expected to raise revenue: We tried that from 1987 to 1996 and realized gains soon dried up. Long-term capital-gains taxes accounted for 9 percent of individual-income-tax revenue from 2003 to 2007 compared with 6.9 percent from 1987 to 1996, as shown in Table 4 of my latest paper, on the misuse of the top 1 percent of income shares as a measure of inequality.
Romney’s tax reforms have a far better chance of generating enough revenue to cover spending that amounts to 20 percent of GDP than Obama’s punitive tax rates have of financing spending closer to 23 percent of GDP.
This is not least because Romney’s plans to reduce tax distortions and disincentives are enormously favorable to economic growth. Meanwhile, Obama’s tax plans are hostile to extra effort or investment if it results in any person or small business earning more than $250,000. Who, exactly, is going to have a hard time closing the deficit?
— Alan Reynolds is a senior fellow with the Cato Institute and the author of a critical new study about “top 1 percent” incomes.