Romney’s Proposal to Cut to Zero the Taxes on Income from Wealth for those Making Up to $200,000

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Having just watched the second presidential debate between President Obama and former Governor Romney, I want to make a quick point on Romney’s tax proposals that have not been much commented upon.

It is well known that Romney has proposed a tax plan where he would cut all individual income tax rates by 20%.  It is accepted by all, including Romney, that this by itself would cut tax revenues by about $5 trillion over ten years, but that Romney then says he would also cut certain (but unspecified) tax deductions and other preferences in the tax code so as to raise back that $5 trillion and thus make the overall plan revenue neutral.

While this has been much discussed (and the impossibility of doing this without increasing taxes on the middle classes has been noted by neutral observers, including the Tax Policy Center, a group that Romney himself had praised during the Republican primaries), certain other aspects of his tax proposals have been less discussed.  One, which Romney highlighted in the debate tonight, would be that he would cut to zero the income earned from dividends, interest, and long term capital gains, for all households earning up to $200,000 a year.

Note what this implies.  Suppose you are someone who has $4 million in wealth.  Perhaps you inherited this from someone, or struck it rich in the stock market, or won the lottery.  And suppose you are earning a modest 5% on this $4 million from dividends plus interest plus long term capital gains.  You would then be receiving $200,000 a year from this wealth.  While perhaps not really rich, the income is good enough for you, so you do not work.  Under Romney’s proposal, you would pay zero in federal taxes.

In contrast, suppose you work for a living, earning $100,000 a year (or half of what the better off individual described above earns simply from his wealth).  You would pay Social Security and Medicare taxes at a rate of 15.3% on this (total, including the half that is nominally is “paid by” the employer, which all analysts, including Republican ones, agree comes out of worker wages).  You would also be in the middle of the 25% tax bracket currently for federal income taxes, which would fall to 20% under Romney’s proposal to cut all rates by 20%.

Even ignoring the additional taxes you would pay under Romney’s proposal to reduce or eliminate certain (but unspecified) tax deductions and tax preferences, the individual earning $100,000 a year would pay taxes at a marginal rate of 35.3% ( = 15.3% + 20%).  But the wealthy individual, with $4 million in wealth making $200,000 a year would pay absolutely zero.

How can this be considered fair?

The Recovery of Private Jobs Under Obama, versus the Fall Under Bush. And the Cuts in Government Jobs Under Obama, versus the Rise Under Bush.

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Cumulative growth of private jobs, from January 2009 to September 2012 for Obama, and from January 2001 to September 2004 for Bush

Cumulative growth of government jobs, from January 2009 to September 2012 for Obama, and from January 2001 to September 2004 for Bush

 

[Update on February 2, 2013:  A more recent analysis of these issues, with these charts now covering the full first term of Obama, is available here.]

Private jobs have grown under President Obama while they fell during the similar period of the administration of President Bush.  And government jobs have fallen during Obama’s term while they rose under Bush.  The figures above, prepared from data from the Bureau of Labor Statistics, shows the cumulative change in the number of private and government jobs, respectively, from their inaugurations to September of the fourth year of their administrations.  This updates similar graphs and analysis posted earlier on this blog (here and here), although with a focus now on only Obama and Bush.

Obama has been heavily criticized by Republican nominee Mitt Romney and by Republicans more generally for doing a terrible job on jobs.  Their repeated theme is that the US has to return to the policies of George W. Bush of tax cuts, deregulation, and small government in order to create a “business friendly” environment in which private businessmen will then create jobs.

But as the top graph shows, private jobs have grown under Obama, in contrast to a fall under Bush.  Obama was faced with a collapsing economy when he took office, with private jobs falling by 800,000 a month as he was taking office.  He was able to turn this around within only a few months, as the stimulus package and other measures entered into effect, and jobs growth turned positive after just one year in office.  This was a strong turnaround from the sharpest downturn the US economy had faced since the Great Depression.

Since then, private job growth has continued each and every month, but at an overall pace that has been criticized.  But the pace of recovery has in fact been better than that observed under Bush, where the number of private jobs had fallen steadily for the first two and a half years into his term (and with the fall starting only after he took office, in the Spring of 2001).

Based on the current official numbers, there were about 0.5 million more private jobs in September 2012 than when Obama took office.  This already contradicts the Republican claim that Obama’s policies have been destroying jobs.  And the growth in private jobs has in fact been even higher.  The BLS recently announced their preliminary estimate that in their regular annual re-benchmarking process, the number of private jobs were 453,000 higher in March 2012 than previously estimated.  This would be an increase of 0.4% over the previous BLS estimate for private employment, and such a change is about average.  Over the eleven years of 2002 to 2012, the changes due to the annual benchmark re-estimates have ranged between 0.1% and 0.9% (in absolute terms) – sometimes positive and sometimes negative.  The BLS has not yet revised their job estimates reflecting this new benchmark; this will be done in early February 2013, when the revisions will be announced along with the January 2013 job figures.

Based on the pattern observed in the previous annual re-benchmarking exercises, the March figure is likely to change by about the amount of the benchmark change (it will not be exactly the same for a number of reasons), with changes before that reaching back into 2011 diminishing as one goes back to the previous March 2011 benchmark period, and the changes increasing as one goes forward in 2012 from the March 2012 benchmark.

Until the new analysis is done by the BLS experts and the standard models run, there is no way to say what the changes will be.  For the diagrams above, I have very simplistically simply raised each of the 2012 private job estimates by 453,000, to give one a visual sense of the magnitude of the change.  In reality, the increase will be phased in rather than jump abruptly as depicted, but it is not yet known how it will be phased in so I have not tried to show this.

Based on this simple assumption, private jobs during Obama’s term from his inauguration to September 2012 have increased by about 1.0 million.  During the similar period under Bush, private jobs fell by 1.5 million.  Yet Obama is criticized for his job growth record, while Bush is praised.

Furthermore, since the turnaround in jobs that Obama was able to achieve after just one year in office, private jobs have increased by 4.7 million based on the current official estimates, or by 5.2 million with the adjustment made for the new benchmark

While private jobs have grown under Obama (in contrast to the fall under Bush), government jobs have fallen under Obama (and grew under Bush).  Again, this contradicts the repeated Republican charge that Obama has presided over an explosion of government jobs and government spending, which is simply not true.  (Note that the temporary blip seen in the 16th month after Obama’s inauguration is the temporary hiring for the 2010 census.  After a few months, government jobs returned to their previous path of decline.)

As seen in the figure above, government jobs have fallen by 575,000 during Obama’s term up through September 2012, using the current official BLS estimates.  But the BLS benchmark revision, discussed above, estimates that there were 67,000 fewer government jobs in March 2012 than previously estimated.  Adding this as a simple adjustment, government jobs fell by 642,000 during Obama’s term in office so far.  Keep in mind that these are primarily state and local government jobs, as they account for 87% of government jobs in the US.  But federal jobs have been flat over this period with no sharp increase either, and fell if one excludes an increase in the number of Defense Department employees.

And in contrast to the fall in government jobs during Obama’s tenure, government jobs rose during the similar Bush period.  Between his inauguration in January 2001 and September 2004, government jobs rose by 800,000 under Bush.  There would be over 1.4 million additional jobs (mostly of school teachers, police, and other state and local workers) due to the direct impact alone if government jobs had been allowed to grow as they had under Bush rather than fall as they have under Obama.  With a multiplier of two, there would be 2.8 million more jobs, and unemployment would be 6.0% instead of 7.8%.  Unemployment would then be at the top end of what is generally considered to be the full employment range of unemployment (which will never be zero, due to turnover and other frictions).

The myth is therefore quite different from the reality.  Government jobs have been cut back during Obama’s term, and this has acted as a considerable drag on the economy.  If government jobs had been allowed to increase during Obama’s term by as much as they had under Bush, we would now be at, or close to, full employment  (see some further estimates at this blog posting).  Yet Republicans continue to call for further and drastic cut-backs in government, with no recognition that there have already been sharp cuts and that these cuts have held back the pace of recovery.

Government Expenditures Leading Up To Presidential Re-Elections: Falling Under Obama, While Rising for Others

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US Government expenditures before Presidential re-elections, Reagan, Clinton, Bush, Obama

Despite the continued rhetoric that government expenditures have exploded under Obama, the truth is the opposite.  Government expenditures have been contracting in the period leading up to the election.  This contraction has led to slower economic growth and has hurt Obama’s re-election chances.

Previous posts on this blog (here, here, and here) have looked at the paths of government expenditures and government employment from either presidential inauguration dates or around business cycle peaks.  This post will look at the paths leading up to re-election dates.

The figure above shows the path government expenditures have followed in the 2 1/2 years leading up to the presidential re-election dates, for Obama as well as Reagan, Clinton, and the second Bush.  The data is taken from the GDP accounts, and shows real government expenditures on consumption and investment, a component of GDP.  They come from the Bureau of Economic Analysis of the US Department of Commerce.  Note that this is all of government, including state and local.  We do not yet have data yet for the third quarter of 2012 (the initial estimate will be released later in October) nor obviously for the fourth quarter.  But the pattern is clear.

Government expenditures (including state and local) have been falling steadily and sharply under Obama in the period leading up to the re-election date, and as of the second quarter of 2012 were over 5% below where they were in the second quarter of 2010.  At the comparable point under Clinton they were over 2% higher, under Bush Jr. they were 4% higher, and under the conservative idol Reagan they were 7 1/2% higher.  Stated another way, government spending under Obama as of the second quarter of 2012 would have had to been 13.4% higher to have matched where it was under Reagan.

Government expenditures continued to rise rapidly under Reagan.  By the date of the 1984 election, the expenditures were 10 1/2% higher in real terms than 2 1/2 years before.  While Reagan is praised as a small government conservative, his re-election was helped immensely by this rapid growth of government.  This growth in government spending led to growth in demand for the production that could be provided from the then unemployed workers, and sparked the recovery from the 1981/82 downturn.  Unemployment reached a peak of 10.8% in late 1982 under Reagan, substantially higher than the peak of 10.0% under Obama.  But with government then expanding under Reagan, rather than contracting as under Obama, the unemployment rate fell rapidly under Reagan to 7.3% in September 1984, vs. 7.8% under Obama in September 2012.

The impact of the growth in government under Reagan instead of the contraction under Obama can be estimated using the GDP accounts issued by the BEA.  The growth of GDP can be broken down into the contributions to that growth from the individual components making up GDP, one of which is government spending.  During the ten quarters from mid-1982 to the last quarter of 1984, GDP growth averaged 5.2% at an annualized rate under Reagan.  This was indeed a good rate of growth from the sharp downturn experienced in 1981/82 at the start of the Reagan term.  Of this 5.2% rate of growth, the growth in government spending accounted for 0.85% points.  In contrast, the rate of growth under Obama from mid-2010 to the second quarter of 2012 (the most recent period with data) was 2.0% (annualized), well below the 5.2% rate of growth under Reagan.  But Obama’s growth was dragged down by a contracting government, by 0.55% points.  The figures are summarized in the following table:

Impact of Govt growth at level of other president
Govt contribution to GDP growth (annualized) GDP growth (annualized) Direct Impact Multiplier of Two
Reagan – 1982Q3 to 1984Q4 0.85% 5.2% 3.8% 2.4%
Obama – 2010Q3 to 2012Q2 -0.55% 2.0% 3.4% 4.8%
difference 1.40%

With government growth adding 0.85% points of GDP growth under Reagan, but subtracting 0.55% points under Obama, the net difference is 1.40% points of growth.  If government spending under Reagan had fallen as it had under Obama (that is, had the contribution been 1.4% points less), the rate of growth of GDP under Reagan leading up to the election would have been only 3.8% annualized due to the direct impact alone, and only 2.4% with a multiplier of two on such expenditures.  Looked at from the base of what growth was during the Obama period, growth (from the direct impact alone) would have been at a 3.4% rate had government been allowed to expand during the Obama term at the rate it had under Reagan, and growth would have been at a 4.8% rate with a multiplier of two.

Put another way, if government spending had declined during the Reagan period at the rate it had during Obama’s term, the estimated resulting growth rate of 2.4% a year (assuming a multiplier of two) would have been similar to the 2.0% rate seen under Obama.  Symmetrically, if government spending during the Obama period had been allowed to grow as it had under Reagan, the estimated resulting growth rate of 4.8% would have been similar to the 5.2% seen under Reagan.  These resulting growth rates are similar for each.  The different paths followed for government spending can by itself account for the differences in the growth rates observed between the Reagan and Obama periods, when government spending rose under Reagan but fell under Obama.

A final issue to address is whether the fall in government spending under Obama since mid-2010 is a reflection of a sharp jump early in his administration (due perhaps to the stimulus package or whatever), from which a decline would be easy.  This is not the case.  Government spending in the second quarter of 2010 was 3.9% higher (total, not annualized) than it was in the fourth quarter of 2008, the last quarter of Bush.  The total growth under the similar period under Reagan was 2.8%.  The difference is just 1.1%.  But as noted above, government spending was 13.4% higher by the second quarter of 1984 than it was at the same point in the Obama term.  The 1.1% is minor compared to this 13.4%.

The stories being told on the efficacy of the Obama and Reagan policies might therefore be quite different if one recognizes that despite the rhetoric, government expanded under Reagan while it contracted under Obama.  Had government spending grown during the Obama term at the pace it had during the Reagan term, the economy would have grown similarly fast.  Obama could then be running similar “Morning in America” ads as Reagan did, rather than explaining that while America has been heading in the right direction, there is much more to do.