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3Qs: ‘Bad math’ or ‘bold leadership’?

Mitt Romney, the Republican presidential nominee, has pledged to cut all income tax rates by 20 percent, a plan that would cost the government some $4 trillion in forgone revenue over the next decade. But he has also vowed to offset the lost revenue by reducing tax deductions and exemptions for high-income earners without raising taxes on middle-class families. President Obama, on the other hand, has pledged to extend the President Bush-era tax cuts for households making less than $250,000 and require individuals making more than $1 million to pay at least a 30 percent tax rate regardless of their income source.

We asked Peter Enrich, a professor of law in the School of Law at Northeastern University who previously was general counsel to the Massachusetts Executive Office for Administration and Finance, to analyze the tax plans put forth by Romney and President Obama.

President Obama has called Romney’s tax plan “bad math” rather than “bold leadership,” noting that it cannot possibly close the budget deficit without raising taxes on middle-class families. Simply put, is President Obama correct in his assertion? Why or why not?

To be fair, Romney has never suggested that his tax plan would reduce the budget deficit. He has been clear that he doesn’t see this as a time to raise taxes, even on the wealthy, and has insisted that reducing the deficit needs to be accomplished entirely by spending cuts, not tax increases.

But Romney does claim that his tax plan, despite its sharp cuts in tax rates for wealthy taxpayers, would not reduce their taxes, because of offsetting reductions in their tax breaks. He has refused, however, to identify which tax breaks he would propose to eliminate, and has apparently taken off the table the items that could amount to real money, most notably the preferential tax rates for capital gains and dividend income (the vast preponderance of which go to the wealthiest taxpayers).

As a result, most analysts agree that the Romney plan would either significantly increase the deficit or would need to rely on substantial tax increases for middle-class taxpayers even to keep the deficit at present levels.

Romney has been reticent to discuss the tax expenditures that he would eliminate in order to pay for his proposed tax cuts, making it difficult for economists to analyze the plan’s impact on families and businesses. If you were Romney, which tax breaks would you eliminate — and how would they affect the economy?

By far, the most glaring and unjustified tax expenditure for individuals is the preferential treatment of capital gains and dividends, which are taxed at a maximum rate of 15 percent. This is the rule that allows Warren Buffett and Mitt Romney to pay far less in taxes than middle-income workers. Some 75 percent of capital gains are earned by the top 1 percent, so the benefits of preferential taxation go almost entirely to the very rich. Reagan eliminated preferential treatment of investment income in his 1986 tax reform. And there is no serious evidence that higher taxation of investment income leads people to invest less or harms the economy.

With regard to business taxes, while it’s true that the U.S. has among the highest nominal corporate tax rates, a vast array of tax breaks allow typical large businesses to pay only half that rate, and many large and profitable companies can avoid federal taxes altogether. Closing a wide range of these loopholes, and using a portion of the resulting revenue to reduce corporate rates, would make the tax system fairer and more efficient, while helping to reduce the deficits.

A study commissioned by pro-business advocacy groups has found that President Obama’s plan to eliminate the Bush-era tax cuts for high earners would force small businesses to cut wages and cost the United States approximately $200 billion in economic output and 710,000 jobs. Whose tax plan is more business-friendly: Romney’s or President Obama’s?

Figuring out the long-term impacts of tax policy on the economy is tough. While taxes surely have some impact on economic activity, government spending is at least as significant an influence on the economy, both by providing needed supports for productivity (such as education and infrastructure) and by its stimulative effect on purchasing power. And there is also reason for concern that excessive government debt, caused by an imbalance between taxes and spending, may ultimately stall the economy. Where the optimal trade-offs lie between spending, taxes and deficits is highly uncertain.

What seems reasonably clear, however, is that restoring taxes on the wealthy to pre-Bush era levels is unlikely to cause economic harm. After all, the economy was thriving in the Clinton years, when taxes on the wealthy were at the higher rates.  And it defies common sense and economic logic to fear that business owners would choose to reduce investment in their businesses simply because taxes were going to take a larger fraction of their profits, at least not if profits from alternate uses of their resources would be taxed at comparable rates.