Why Won’t Romney Explain His Tax Plan? Because the Romney Tax Plan is the Enactment of a VAT

The contents of Romney’s tax plan, like the contents of Romney’s personal tax returns, have been a continuing enigma throughout Romney’s election campaign. All the tax policy issue has taken a backseat to the tax returns issue, recently it has been the subject of renewed attention, from objections lodged by economists skeptical of the tax policy’s soundness, to Obama operatives who, sensing blood in the water, have taken to ridiculing Romney’s Lucy-with-the-football routine regarding the specifics of the tax plan.

These criticisms are fair. Although some economists do support Romney’s claims in theory — noting that there are “possible” explanations that could result in Romney’s tax plan actually working out — none have admitted to actually having had a chance to look at the details. But other economists have taken to pointing out that the emperor has no clothes. William Gale, the co-director of the Urban-Brookings Tax Policy Center, has gotten publicity from both sides of the aisle for his own derision of Romney’s tax plan, due to his attempt at debunking Romney’s claim that his plan is revenue neutral. In attempting to evaluate ‘the full Romney tax plan’ — a tax plan “which, by the way, does not exist,” Gale is quick to note — Gale and two other economists concluded that

a revenue-neutral plan that met five specific goals that Governor Romney had put forth (reducing income tax rates by 20 percent, repealing the estate tax, the alternative minimum tax, and capital income taxes for middle class households, and enhancing saving and investment) would cut taxes for households with income above $200,000, and—as a result of revenue-neutrality—would therefore necessarily have to raise taxes on taxpayers below $200,000.

Michael Graetz has also attacked Romney’s claims that broadening the tax base would be sufficient to pay for his tax cuts:

“You can’t get enough base-broadening to finance his rate reductions,” says Michael Graetz, a Columbia Law School professor who was a top tax official in President George H.W. Bush’s Treasury Department. “Romney says what he will do on tax cuts but he’s not prepared to say what he would do on the hard stuff.”

But Romney continues to be coy regarding any details of his tax plan, as he has been throughout the election. The only specific points that Romney has offered in defense of his plan’s claim to revenue neutrality are that “[the] tax cuts would be paid for through a combination of reduced tax breaks and the economic growth his plans would generate.” But these ‘specifics’ are really more like ‘vague generalities.’

In that vein, a recent Fortune article examined where these two items could actually result in a revenue neutral tax plan:

The debate over the Romney fiscal plan has gotten stuck on the revenue side of the equation, namely, how the tax cut would impact the amount of money coming into the Treasury. The Romney campaign insists that the tax cut is what they call “revenue neutral,” meaning that it would essentially pay for itself. There are only a few ways that this could be possible: 1) If taxes will ultimately be going up for certain tax payers through the elimination of deductions or 2) If the amount of economic growth generated by the tax cuts would increase revenue as more people start paying into the system or 3) A combination of both.

Fortune concluded that “[e]ven under the most generous economic assumptions, Mitt Romney’s tax plan simply doesn’t work.” Although, in theory, increased economic growth and elimination of income tax deductions could offset — at least to some degree — the effect of the Romney tax cuts, Romney won’t provide any of the supporting details that are necessary to bolster that conclusion. Namely, (1) Romney refuses to actually identify what deductions would actually be eliminated, and (2) Romney’s reliance on “economic growth” to explain how his tax plan could pay for itself is maddeningly circular — it is self-justifying and impossible to evaluate in the absence of specifics.

But the Fortune article overlooks the third possible mechanism by which the Romney Tax Plan could actually be revenue neutral; through the implementation of a new, non-income based form of taxation.

In other words, the missing piece of the Romney Tax Plan puzzle is the VAT.

If the VAT is the secret ingredient of the Romney Tax Plan, it would explain why Romney has continued to insist that his tax plan really can lower the income tax rate across the board while also remaining revenue neutral, and why Romney has refrained from actually identifying which deductions he is going to axe in order to pay for his tax cuts. Because Romney knows that his plan doesn’t actually need to get rid of deductions — the Romney tax cuts are not offset by increasing the proportion of household income that is subject to income tax, the Romney tax cuts are offset instead by another tax.

Romney has previously admitted, during the primary-era of the 2012 election cycle, that he was drawn to a VAT-style taxation system that, for reasons of political expediency, was layered onto the existing income tax system:

He notes that “my 59-point modest plan are immediate steps I’ll take on Day One and that the steps I will take Day Two include moving toward a Simpson-Bowles-style lower tax rate, a broader base tax system. . . . People say, ‘Well, let me see that plan.’ It’s like, ‘That’s going to take a lot more analysis and modeling than I have the capacity to do in the confines of a campaign.’ But I will campaign for lower tax rates and a broader base of taxation.”

What about his reform principles? Mr. Romney talks only in general terms. “Moving to a consumption-based system is something which is very attractive to me philosophically, but I’ve not been able to sufficiently model it out to jump on board a consumption-based tax. A flat tax, a true flat tax is also attractive to me. What I like—I mean, I like the simplification of a flat tax. I also like removing the distortion in our tax code for certain classes of investment. And the advantage of a flat tax is getting rid of some of those distortions.”

Since Mr. Romney mentioned a consumption tax, would he rule out a value-added tax?

He says he doesn’t “like the idea” of layering a VAT onto the current income tax system. But he adds that, philosophically speaking, a VAT might work as a replacement for some part of the tax code, “particularly at the corporate level,” as Paul Ryan proposed several years ago. What he doesn’t do is rule a VAT out.

There is ample evidence out there that that the apparent voodoo employed by the Romney tax plan, in reaching the conclusion that the plan is revenue neutral, can in fact be explained by the plan’s previously unmentioned inclusion of a VAT, or some other form of consumption tax. Romney’s own policy documents frequently reference studies based on consumption taxes. See, for instance, the Romney Program for Economic Recovery, Growth, and Jobs — a policy plan which the Economist described as “like ‘Fifty Shades of Grey’ without the sex.” Although the Romney Program for Economic Recovery does, indeed, splash out a lot of sensational language while remaining totally devoid of any substance, the documents isn’t notable for the specific policy proposals it contains (because, well, there aren’t any) but rather for the specific authority it relies upon in support of its disjointed claims of accelerated GDP growth and increased job creation.

True, the main text of the Program does not directly allude to a consumption tax, but it doesn’t provide for any other sort of concrete policy proposals either — the document reads like a horoscope, or an ad for a pay-per-call psychic, explaining how Romney will “unlock[] the potential for innovation, investment, and initiative in America’s dynamic economy” through the enactment of “four main economic pillars.” One of those pillars is Tax Reform:

Reform The Nation’s Tax Code To Increase Growth And Job Creation.

    Reduce individual marginal income tax rates across-the-board by 20 percent, while keeping current low tax rates on dividends and capital gains. Reduce the corporate income tax rate – the highest in the world – to 25 percent.
    Broaden the tax base to ensure that tax reform is revenue-neutral.

Romney then argues that enactment of this pillar will result in fantastic gains for the American economy, as “[a] significant body of economic research concludes that fundamental tax reform could increase real GDP growth over the next decade by 0.5 to 1 percentage point per year. Kevin Hassett and Alan Auerbach surveyed the literature and found that tax reform could increase output by between 5 and 10 percent.” The article referenced is Hassett and Auerbach’s survey, Toward Fundamental Tax Reform (2005), and the following excerpt from that article appears to be the source of the Program’s projected numbers:

Based on results from a fairly large number of different models, the literature suggests that a wholesale switch to an ideal system might eventually increase economic output by between 5 and 10 percent, or perhaps a slightly wider range.

There are two glaring points to be made here. First, the studies that Romney is relying on for his projected GDP growth are based upon an assumption of a “wholesale switch” from the current tax system to an “ideal system” — but these studies almost uniformly conclude that such a “wholesale switch” would be politically impossible. Not to mention the fact that these projections require Romney to address the trillion dollar question of what the “ideal system” is — a question for which most of the authors he cites to have contradicting answers.

But the research Romney’s Program uses to justify his projected numbers all have something in common. Although the survey explores a variety of differing and contradicting proposed tax reforms, almost all of the proposals include, to some degree, a consumption tax component — despite the fact Romney’s own platform has never alleged that he too is proposing a tax plan containing a consumption tax.

From what we know of Romney’s tax plan, however, there do appear to be a number of similarities with the VAT proposal set forth by Michael Graetz in chapter three of the Hassett and Auerbach survey, “A Fair and Balanced Tax System for the Twenty-first Century”:

The Corporate Income Tax. Lower the corporate rate to 25 percent, and more closely align book and tax accounting. …

Enact a Value-Added Tax. To replace the revenues just lost, enact a value added tax at a 10–14 percent rate. … In order to keep the tax rate as low as possible, the VAT tax base should be broad, covering nearly all goods and services. A broad VAT tax base with a single tax rate would minimize its economic distortions, and limiting exemptions would simplify compliance and administration

Hmm. Lower the corporate tax rate to 25%, and then use a broadened tax base to offset to ensure that the tax reform is revenue neutral? Now where could I have possibly seen that before…

One key point where Graetz’s plan and Romney’s proposal apparently differ is that, for personal income taxes, Romney has proposed that we “[r]epeal the Alternative Minimum Tax (AMT),” while Graetz, in apparent contrast, has proposed that we

“[l]ower the [Alternative Minimum Tax] rate to 25 percent and repeal the regular income tax. Everybody seems to want to repeal the AMT; let’s repeal the regular income tax instead. … Most of the special income-tax credits and allowances that now crowd the tax code and complicate tax forms would be repealed. But the deductions for charitable contributions, home-mortgage interest, and large medical expenses would be retained.”

But on a second look, Romney’s plan to repeal the AMT could in fact be equivalent to Graetz’s suggestion that we replace the current tax system with a modified AMT. We know that Romney has stated he would keep his tax plan revenue neutral by eliminating deductions — but we also know that Romney has a snowball’s chance in hell of touching the politically popular deductions for charitable giving, home-mortgage interest, and medical expenses. But if Romney’s plan to “eliminate the AMT” involves cutting marginal income taxes 20% “across the board” while “reduc[ing] tax breaks” — then, well, it would look a lot like Graetz’s plan.

Romney’s plan also bares some resemblances to William Gale’s discussion, at chapter two of the Hassett and Auerbach survey, of what a consumption tax ought to look like, even if Romney avoids specifically identifying the consumption tax component of his plan:

A well-designed consumption tax would (a) collect adequate revenues to cover expenditures over time and avoid reducing national saving through higher government deficits; (b) broaden the base to lessen interference in the economy; (c) tax already-existing capital—that is, concentrate any revenue relief on new saving or investment; and (d) treat interest income and expense in a consistent manner.

The irony is that Gale and Graetz have both gone on the record decrying Romney’s tax plan as a sham, noting that the disclosed details of Romney’s plan don’t add up. But what Gale and Graetz may have failed to consider — and what Romney’s justification for citing to Gale and Graetz’s work as support for his tax policy — is Romney’s plan only appears to be nonsensical because Romney is refusing to disclose the plan’s linchpin component: a consumption tax that offsets the income tax cuts.

Further support for a consumption tax component to the Romney tax plan is also found in the Program’s Appendix, where it references a study that

found that [tax] reform proposals would increase GDP by between 5 and 9 percent over the long run, using a dynamic economic simulation model. (Altig, David, Alan J. Auerbach, Laurence J. Kotlikoff, Kent A. Smetters, Jan Wallsier, “Simulating Fundamental Tax Reform in the U.S.,” University of California, Berkeley, September 29, 1999).

The source of the Appendix’s numbers seems to be from the following excerpt from that article:

We use our model to examine five fundamental tax reforms that span the major proposals currently under discussion. Each reform we consider replaces the federal personal and corporate income taxes in a revenue-neutral manner. The reforms are a proportional income tax, a proportional consumption tax, a flat tax, a flat tax with transition relief, and the X tax.

The proportional income tax applies a single tax rate to all labor and capital income, with no exemptions or deductions. The proportional consumption tax differs from the proportional income tax by permitting 100 percent expensing of new investment. One may think of it as being implemented via a wage tax at the household level plus a business cash-flow tax. The flat tax differs from the proportional consumption tax by including a standard deduction against wage income and by exempting implicit rental income accruing from the ownership of housing and consumer durables. The remaining two proposals modify the flat tax to address distributional concerns. The flat tax with transition relief aids existing asset holders by permitting continued depreciation of old capital (capital in existence at the commencement of the reform). The X tax aids lower-income taxpayers by substituting the flat tax’s single-rate wage tax with a progressive wage tax. To recoup the lost revenue, its sets the business cash-flow tax rate equal to the highest tax rate applied to wage income. Alternatively, one can think of the X tax as a high rate flat tax with a progressive subsidy to wages.

The proportional income tax raises the long-run level of output by almost 5 percent… [and] [t]he proportional consumption tax raises long-run output by over 9 percent.

So, to recap: Romney’s Program for Economic Recovery bases its exuberant claims regarding the effectiveness of Romney’s tax plan on an article which looked at possible GDP benefits of five “fundamental tax reform” proposals — four of which involved a consumption tax component.

If Romney is claiming that his “fundamental tax reform” will result in rampant GDP growth, and Romney uses these studies to prove the alleged economic advantages of the Romney Tax Plan, then, it may be presumed, that Romney’s tax plan is one of the proposed tax reforms that these studies examined. Because the tax plans considered by the studies were overwhelmingly based on the implementation of a consumption tax — and because Romney’s tax plan does not appear to have any overarching similarities to the proportional income tax reform plan — Romney’s tax plan contemplates the implementation of a consumption tax.

This conclusion is hard to avoid, at least without accusing Romney of being a liar. Either Romney’s tax plan contains a consumption tax component — or else Romney has been deliberately relying upon irrelevant and unrelated studies as support for his fantastic claims about the economic benefits of his tax proposal.

Take your pick.