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8 Things to Know about the Candidates’ Tax Policies

Friday, November 2, 2012

It behooves voters to see through the Obama campaign’s political games and understand a few basic facts about the president’s record on taxes and about the impact of Romney’s tax plan.

The Obama campaign’s messaging job on tax policy has been quite impressive, especially given the president’s flawed record on this front.

Over the last four years, President Obama has not only ignored the need for major tax reform, but has also enacted counterproductive changes that narrow the tax base and raise marginal rates. Then, after Republican presidential candidate Mitt Romney presented a tax reform vision that emphasized simplification, fairness, and growth, the Obama campaign refused to engage in a substantive policy debate, instead firing repeated and sometimes false attacks on the accounting assumptions underlying the Romney plan.

As voters head to the polls next week, it behooves them to see through the Obama campaign’s political games and understand a few basic facts about the president’s record on taxes and about the impact of Romney’s tax plan.

Four Things about President Obama’s Tax Policy Record That He (Not Surprisingly) Isn’t Telling You

1. President Obama has raised tax rates — the exact opposite of the reform framework advocated by both Romney and the president’s own Simpson-Bowles Commission. For example, the Unearned Income Medicare Contribution (UIMC) tax enacted as part of the health care law will increase the tax rate on dividends, interest, and capital gains by 3.8 percentage points for high-income households, starting in January. High earners will also face a 0.9 percentage point increase in the payroll tax rate on their wages. These measures are straightforward marginal tax rate hikes — the most distortionary way to raise revenue because they reduce incentives to work, save, and invest.

2. Obama proposes to further increase marginal tax rates by allowing the top tax bracket to increase from 35 to 39.6 percent and the next-highest bracket to rise from 33 to 36 percent for couples earning more than $250,000. Contrary to the president’s repeated claims, this is not simply a return to the top rate of the Clinton era because the 3.8 percent UIMC tax is stacked on top of the 39.6 percent rate for dividends, interest, and capital gains. Add in the effect of the reinstatement of a provision that phases out itemized deductions for high-income earners and the true effective tax rate would be 44.8 percent, higher than at any point during the Clinton administration.

3. Obama has narrowed the tax base by creating additional credits and deductions. According to the Joint Committee on Taxation, the 2009 stimulus law created 14 new tax expenditures. Taxpayers are estimated to spend 6.38 billion hours complying with the current tax system, and much of that time is likely devoted to calculating and documenting various tax credits and deductions. 

4. Obama has embraced one limitation on tax expenditures, proposing that high-income taxpayers be allowed to claim only a fraction of the value of certain tax preferences.  (Specifically, itemized deductions, such as charitable donations, mortgage interest, and state and local taxes, as well as the tax breaks for employer-provided health insurance and municipal bond interest, would be claimed at a maximum rate of 28 percent, despite income being taxed at a higher rate.) He also proposes eliminating the deduction for contributions of conservation easements on golf courses and repealing tax expenditures related to oil and gas production and other assorted tax breaks. But unlike the Simpson-Bowles plan or Governor Romney’s plan, these base-broadening provisions are combined with higher instead of lower tax rates. As a result, effective marginal tax rates, the rates that economists believe influence decisions the most, would rise under this plan.

Four Things about Governor Romney’s Tax Agenda That He (Oddly Enough) Isn’t Telling You

1. Though specifics have not been announced, Romney’s tax plan would reduce the number of tax credits and deductions, thereby simplifying the tax code, broadening the tax base, and permitting lower statutory tax rates, since more income is subject to tax.

2. The pro-growth benefits of Romney’s framework arise from the removal of incentives that distort our choices and misallocate resources across the economy. For example, the current mortgage interest deduction provides a strong incentive for high-income earners to steer their income toward their home and away from investments in business capital. Limiting social engineering in the tax code will promote more market-based allocation of resources. 

3. Romney’s tax plan is not just a change to the individual income tax system but to the entire tax code. The single most distortionary tax in the United States, as Democrats and Republicans seem to agree, is the corporate income tax. Obama has proposed reducing the corporate tax rate to 28 percent while Romney has proposed 25 percent. But the difference between the two plans is more than just 3 percentage points. Romney’s proposal, like the Simpson-Bowles plan, would promote the competitiveness of U.S. multinational corporations by adopting a territorial tax system, like most of our major trading partners. Unlike the current system that taxes income earned abroad when it is returned to the United States, a territorial tax system only taxes profits earned domestically.

4. Romney proposes to keep the top tax rate on dividends and capital gains at 15 percent. This is in stark contrast to Obama’s proposal to almost triple the dividend tax rate and increase the statutory capital gains rate to 20 percent plus the UIMC tax. Combined with his corporate tax rate cut, the net effective tax rate on corporate income would fall under Romney’s plan, while the net marginal rate under Obama’s proposal would be higher than it is today.

The nation desperately needs a simpler, less intrusive, and less distortionary tax system, particularly one that reduces disincentives to save and invest. Such a tax code could accelerate growth and lead, over time, to higher wages for workers. Unfortunately, Romney has failed to push the president to have a meaningful discussion of tax reform, and the president has failed to put forth his own vision for a fairer, pro-growth tax code. But whoever wins the election will face a grim reality: our current tax code is in dire need of repair. Tax reform won’t be an easy political task, but I hope the next president is up to the job. 

Alex Brill is a research fellow at the American Enterprise Institute.

FURTHER READING: Brill also writes “The Romney Tax Plan: Not a Tax Hike on the Middle Class” and “Understanding Tax Fairness (and Why the Buffett Rule Is a Distraction).” Aparna Mathur discusses the “Race to the Top of the Laffer Curve.” Steve Conover explains “The Unfairness of the Buffett Tax.” James Pethokoukis outlines “Taxmaggedon in 2013.”

Image by Darren Wamboldt / Bergman Group

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