1. If one takes a 'static' analysis of the kind defended by the Tax Policy Center – and used for estimating purposes by the Congressional Budget Office (CBO) and Joint Committee on Taxation (JCT) – the Romney proposals do not add up.


2. Conclusion 1 is not greatly modified by adding in certain tax concessions to be taken from high income earners items that the TPC did not include – or which they considered 'off the table'. The point applies a fortiori when we step beyond the question of mathematical possibility to the practicalities of tax design such as the threshold 'notch' – and the inherent desirability and political popularity of some concessions.


3. However the picture does change if the Romney plan is modified by adjusting the income threshold below which people are considered to be 'middle class'. This is the approach taken by Harvard's Martin Feldstein – and backed by other TPC critics. Feldstein does the numbers with a high-income threshold reduced from $200,000 in the unamended Romney plan (the $200,000 figure is not in the plan as described on his campaign website but has been mentioned in interviews).


4. The legitimacy of this move is understandably criticized by Romney critics – change the income threshold and it is no longer the Romney plan. But given the essential arbitrariness of this figure (Feldstein points out his approach would protect 80 percent of taxpayers and a larger proportion of households) it should be up for consideration in a rational debate.


5. Which points to a problem with conducting this sort of debate in a highly charged political context. Instead of considering the broad conceptual issues with various approaches to tax reform, the emphasis tends to be on point scoring rather than analysis of broad approaches – and possible large or small adjustments that could form the basis of compromise.


6. The Feldstein argument raises an important – and neglected – issue. What distributional effect should be aimed for in tax reform? Romney states his plan will be roughly neutral in distributional (as well as revenue) terms. But is this good enough – given the broad trends to greater inequality in recent decades? And what about horizontal equity – the different impact on households with similar income, but different needs (such as dependent children)?


7. Furthermore there has been little attention to the debate about the economic effects of tax reform broadly along the lines proposed by Romney – marginal rate cuts combined with base broadening. Aside from the arithmetic of any specific proposal, is tax reform of this kind desirable? Its supporters point to gains in allocative efficiency that would follow – and consequent economic gains. This broad issue has received little attention in the public debate.


8. The claimed allocative efficiency gains are one aspect of the 'macro-dynamic' benefits that supporters of this kind of tax reform claim. Some Romney supporters have come forward with simulations using economic growth models that aim to capture some of these effects. These models have been criticized – and we have included the debate about them in this visualization. These models – if the claimed effect on GDP stands up – would change the picture significantly.


9. So is it appropriate at this point to state any conclusion about these 'macro-dynamic' effects. There is a fundamental problem here – partly alluded to in the TPC's argument about the need for any such  modeling to take account of the full range of economic policy settings (including the budgetary stance and monetary policy). The problem is that the analysis of tax reform – by both supporters and critics of the Romney plan – has taken place as if tax policy could be considered in a hermetic box, independent of the full set of policies being considered.


10. This is particularly important in the lead-up to the 'fiscal cliff'. Jut about everyone agrees that there is a need for fiscal consolidation over the medium to long-term (though considerable disagreement over what measures are used to achieve it). However the most pressing issue is whether to proceed immediately with an aggressive program of expenditure cuts, as favored by Romney, a less modest program with some tax increases as favored by Obama and the Democrats – or even to add more short-term fiscal stimulus as favored by some Keynesians like Paul Krugman.


11. So it all depends on the 'big picture' – the totality of policy settings that each candidate will attempt to implement. Which raises a raft of further issues. There has been an international debate recently about the approach to fiscal policy while economies are either undergoing a fragile recovery (as with the US) or are in recession (as with parts of Europe). Major institutions, including the IMF and the European Central Bank, have lined up on opposite sides of this debate. Will an early start to fiscal consolidation result in a boost to confidence leading to an immediate lift in GDP growth (the 'confidence channel' according to supporters – the 'confidence fairy' according to critics like Krugman)? Or will it push economies back into recession?

Peter Baldwin
November 2012