11/2/12 - Comparing the Candidates on Taxes

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Nov 2, 2012 12:15:25 PM

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As the election nears, and the race remains tight, I think it’s appropriate to consider what both candidates would mean for various issues. Taxes are certainly one of the most prominent areas of debate, so let’s take a look at both candidates’ proposals and their potential consequences.

Of course, neither candidate has been very forthcoming about what, exactly, he plans to do. We therefore have to make some guesses and inferences about what their general assertions and varied proposals really mean. Another problem is that whatever is proposed by the White House, from either side, must be passed by Congress, which looks likely to be divided again between the Democrats and the Republicans. So, any analysis of the new president’s plans may not be a good guide to what actually happens.

But, with those caveats in mind, let’s take a look. We’ll focus on President Obama first, as he has a record we can use to draw some conclusions.

We know a couple of things about taxes under a second Obama administration. First, they would go up. This is already baked in the cake under the Obamacare legislation. Second, the President has shown a strong rhetorical and political commitment to raising taxes on “the rich,” a classification that has been quite fluid.

The other probable consequence of an Obama re-election would be the continuation of the present tax code. One of the keys of the current code is the ability to promote various behaviors by providing tax incentives, otherwise known as deductions or exemptions. Given the Democrats’ general commitment to activist government, that feature of the code is unlikely to go away. A side effect of preserving the current array of incentives is that high-tax states, which tend to vote Democrat, preserve the state and local tax deduction—a political advantage.

Overall, an Obama re-election would lead to higher taxes for “the rich” and a continuation of the current tax system.

Governor Romney is proposing something different: lower rates overall, but a greatly reduced list of tax incentives. This is actually very similar to the Bowles-Simpson deficit-reduction proposal and would be far more economically efficient than the current system. What it’s explicitly not is a tax cut. Romney has specified that the program would be revenue-neutral—it would raise as much money as the current system—and distributionally neutral, meaning that the rich, middle class, and poor would pay about as much collectively as they do now.

But there have to be winners and losers, if there is any change at all. There are two big things in Romney’s proposal. First, many deductions and exemptions would be eliminated. Second, the effect of the remaining ones would be severely limited for taxpayers above an income threshold.

The people most affected would be those with large deductions, many of which would be eliminated. This includes people with large mortgage interest payments, large charitable deductions, or high state and local taxes. As I mentioned above, those in the last category tend to live in Democrat-voting states. Changing the tax code in this way would provide a huge incentive, at the state level, to keep taxes low since they’d no longer be deductible. In effect, higher-income residents of those states would pay taxes twice on the same income under Romney’s proposal.

Again, the tax hit would be to the rich—and again, that’s an ill-defined category. The Romney plan, however, has the benefit of being more economically efficient and also of closely resembling the Bowles-Simpson plan, which had considerable bipartisan support.

The disadvantage of the Romney plan is that, precisely because it eliminates many deductions and incentives, it would provoke a political death-match between the administration and lobbyists trying to defend their own incentives. The match has already started in many cases, as industries that depend on the incentives try to preserve them. Politically, the Romney plan is a much tougher sell than the status quo Obama plan.

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Tune in to Bloomberg Radio's Bloomberg Businessweek on Friday, February 28, at 3:45 P.M. ET to hear Brad talk about the market. Stream the show live at https://www.bloombergradio.com/, listen through SiriusXM 119, or download Bloomberg's app, Bloomberg Radio+.

Tune into Yahoo Finance's The Final Round on Thursday, March 12, between 2:50 and 4:00 P.M. ET to hear Brad talk about the market. Exact interview time will be updated once confirmed. Watch at finance.yahoo.com

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