Romney’s New Tax Plan a Significant Improvement

Earlier this week Romney released his new tax plan, which is the same as the old plan but with a 20 percent cut across the board in marginal rates on personal income, and elimination of the Alternative Minimum Tax (AMT). There is talk of broadening the base by closing loopholes but no specifics are offered. The new rates would be as follows:

One of Romney’s major weaknesses in his previous plan, which we graded a C-, was that, unlike almost all other candidates, he made no effort to reform the personal code beyond permanent extension of the Bush Tax Cuts. The new plan addresses that with a massive tax cut across the board, but otherwise preserves the current six brackets and umpteen special interest loopholes that create unnecessary complexity and unfairness.

Nonetheless, lowering marginal rates by 20 percent is a significant improvement in that it moves the rate structure closer to a flat tax, where all individual taxpayers would pay the same rate. It also moves in the direction of taxing business income equally, since the top personal rate would be 28 percent and the corporate rate would be 25 percent. This is an important issue since the majority of business income is taxed under the personal code in the form of pass-through entities such as S-corporations, partnerships, and sole proprietorships.

Much of this business income accrues to high-income earners. For instance, about a third of the income of millionaires comes from these pass-through entities. This is in large part because business income is profits, which, unlike wages, fluctuate dramatically from year to year, e.g. a typical small business might make a $1 million one year and lose a $1 million the next. So dropping the top personal rate to 28 percent has two benefits: 1) Federal tax revenues would be less volatile from year to year, as there would be less reliance on volatile pass-through business income. 2) Small businesses would have significantly more after-tax profits to reinvest in wages, new workers, and equipment. The lower top marginal rate would also increase the supply of high-productivity labor. Empirical evidence suggests this would go a long way to addressing our current economic malaise and high unemployment rate.

Lastly, Romney joins the other candidates (except for Ron Paul) in eliminating the AMT. This simplifies the tax code significantly.

Because of these improvements, Romney’s tax plan goes from a C- to C+. According to our grades of all Republican candidates’ tax plans, this puts Romney in second place, tied with Gingrich. Ron Paul still receives the highest grade, mainly because his plan eliminates taxes on capital gains and dividends and lowers the corporate rate to 15 percent:

Paul: B-

Gingrich: C+

Romney: C+

Santorum: D+

Follow William McBride on Twitter @EconoWill