http://online.wsj.com/article/SB10001424052970203918304577239092290860440.html?mod=WSJ_Opinion_LEADTopRomney's Tax Reboot
His 20% marginal rate cut changes the tax reform debate.
One oddity of this Republican Presidential primary season is that front-runner Mitt Romney has had by far the least inspiring tax plan. That changed yesterday when the former Massachusetts Governor took a dive into the deep end of the tax reform debate with a proposal that includes a 20% across-the-board cut in income tax rates. Now we're getting somewhere.
The rate cut follows the Reagan formula of applying to anyone who pays income taxes. The current 35% tax rate (set to rise to 41% in 2013 including deduction and exemption phase-outs) would fall to 28%, the 33% rate to 26.4%, the 28% rate to 22.4%, the 25% rate to 20%, the 15% rate to 12%, and the 10% rate to 8%.
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As an economic matter, this is the most effective kind of tax cut because it applies at the margin, meaning the next dollar of income earned. A mountain of economic research shows that a marginal-rate cut does far more than tax holidays or targeted tax credits to change the incentives to invest and hire workers, and thus provides the most economic lift.
The proposal from Mitt Romney, above, provides a tax contrast with Rick Santorum.
This is especially true because the vast majority of businesses in America today aren't corporations. They're sole proprietorships, partnerships or Subchapter S firms whose profits are "passed through," as the jargon goes, to the owners and are taxed at the individual rate. These noncorporate firms account for over half of all business income, according to IRS data. By lowering their taxes and making the rates permanent, Mr. Romney's plan would do much to make the U.S. more job and investment friendly.
By contrast, President Obama's proposal yesterday (see below) to cut the corporate rate to 28% from 35% wouldn't apply to this "pass-through" business income. It would thus favor big corporations at the expense of smaller businesses that file as individuals and would see their marginal rate rise to 41% or more under Mr. Obama's plan to raise individual tax rates.
Mr. Romney has already proposed a cut in the corporate tax rate to 25% from 35%, and by adding the cut in the business pass-through rate to 28% he is proposing the more ambitious and far more economically potent reform.
The Obama campaign will attack his plan as favoring the rich, but it would do so even if Mr. Romney proposed no tax cut. Now Mr. Romney will have a better response because in return for cutting rates he says he would also close loopholes and deductions that have become shelters from high tax rates.
Mr. Romney made the mistake yesterday of distinguishing between deductions for "middle-income families," which he said would be preserved, and for the "top 1%," which he said would be on the table. This sounds like a pollster's bad advice. It merely plays into Mr. Obama's class-war theme when Mr. Romney should be stressing growth. But at least Mr. Romney says all deductions would be on the reform table, including those for mortgage interest, state and local taxes and health care.
The Romney campaign is also shrewd to say it will assume some dynamic revenue feedback from his marginal-rate cuts. This does not mean that the tax cuts will entirely "pay for themselves" right away. It does mean that it can safely assume that his proposal would recapture about one-third of the revenue loss from the rate reductions through more investment and economic growth.
That's a defensible and conservative estimate based on historical experience with rate reductions. Tax revenues soared after the Reagan 1981 tax cuts (the Gipper cut rates across the board by 25%) and the Bush 2003 rate reductions. The 2003 investment tax cut was expected to lose revenue, but the gain in jobs and business activity produced $786 billion more in revenue from 2003-2007.
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Economists Greg Mankiw and Glenn Hubbard, who are both advising Mr. Romney, have done studies documenting the feedback effects of marginal-rate tax cuts. So has Harvard's Martin Feldstein, among others.
All of this should also help Mr. Romney politically, if he makes the case well and with confidence. Conservative voters who have wondered if he is one of them can now see a tangible proposal that will be a governing priority, not merely a pledge to fight for reform some day. It gives him something to fight for beyond his business biography.
The Romney proposal will also provide a tax contrast with Rick Santorum. The Pennsylvania Senator favors a top tax rate of 28% but he also wants to triple the child tax credit to $3,000. He'd have a hard time credibly doing both without blowing up the budget because the tax credit has almost no revenue feedback effect. It's a social gesture with little or no impact on economic growth.
Meanwhile, on corporate taxes, Mr. Romney's tax cut applies to all companies equally. Mr. Santorum would cut the rate in half for most companies, except manufacturers would pay 0%. This is a form of industrial policy that would have every company lobbying to qualify as a manufacturer and would defeat the tax neutrality that is a main goal of tax reform.
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Now that he has the right policy, Mr. Romney's main challenge will be selling it without apology. He has resisted tax cuts for individuals lest he be criticized for helping the rich, and he sometimes sounds guilty about his own wealth. But voters will sense if Mr. Romney doesn't believe what he says or if he shrinks from making a forthright case for it.
The only way to defeat Mr. Obama's politics of envy is with the politics of growth and rising opportunity. Voters don't really care about a candidate's wealth as long as they conclude he has a plan to increase theirs.
