Mitt Romney has stated that his proposed tax cut would be revenue neutral, in part because it would help restore a healthy economy. He's taking credit for the increase in tax revenue from that additional economic activity to help offset his decreases in tax rates. The rest of the tax rate cut will be made up through closing loopholes, primarily on upper income taxpayers. While Romney has not yet made his full calculations public, he has now made public enough information to make a reasonable approximation to his calculations, at least with respect to personal income taxes. The question is, do the numbers work out? To address this question, let's lay out the information Romney has made public: 1. All earned income tax rates will be cut by 20%  one fifth. The 35% bracket will become a 28% bracket, the 10% bracket will become an 8% bracket, etc. Capital gains would continue to be taxed at 14%  except that for incomes below $200,000, there would be no taxes on capital gains, dividends, or interest. 2. 12 million new jobs will be created over the next 4 years. Since this is an assumption, we'll examine the reasonableness of this assumption before using it. 3. Personal income tax deductions will be capped  numbers for the cap range from $17,000 to $50,000  and the deductions would be phased out for higher income taxpayers. Now, we're going to make some simplifying assumptions. a. Because capital gains, dividends, and interest income are generally minimal for those with incomes below $200,000, we're going to ignore the effect of removing those taxes on that income. b. Because Romney has not said where the deductions would be phased out, we're going to ignore the phaseout and assume that the capped amount of deductions can be taken by anyone. Now, on to the calculations. First, let's look at the tax cuts. Tax rates on earned income, which accounts for about 90% of tax revenues, would be cut by 20%. Tax rates on capital gains, accounting for the other 10% of tax revenues, would not be cut. The net tax rate cut would be 90% x 20% = 18%. To compensate for the reduced tax rate and keep revenues constant, the tax base must be increased. Specifically, the tax base will need to be increased by 22% to bring us back to 100% of revenues: (1  0.18) x (1 + 0.22) = 100. Now, let's go to the first element of increasing the tax base  the number of additional jobs. The estimate of 12 million new jobs over 4 years  250,000 per month  is what forecasting firms estimate ought to be happening in a normal healthy recovery today. It would bring us to an employment to population ratio of 0.477 at the end of 2016. Since this is almost a full percentage point below the peak employment to population ratio of about .485 in 2007, this seems like a more than reasonable estimate of new job creation under an improved tax regime. The tax cut doesn't get full credit for all those additional jobs, though. Since the end of the recession, jobs have been created at approximately what's needed to keep up with population growth. That's 4.5 million jobs over the next four years  coincidentally equal to Obama's job creation claim for his term, measured since the bottom of the recession. The Romney tax cut only gets credit for additional jobs beyond that number  7.5 million additional jobs over 4 years. That's 5% more jobs than would exist without the tax cut. In addition to the increase in jobs, the tax cut should result in increased hours worked and increased wages. Romney hasn't given a number for this, but over the past 4 years, median real income has dropped by 8%. It's reasonable to expect that, with the Romney tax cuts, real income will recover by at least that amount, to the levels at which it was largely steady for the decade before the 2008 recession. To avoid making the calculations too complex, we'll ignore the fact that income gains come at the marginal tax rate and push some people into higher tax brackets, and assume that the tax revenue gain is proportional to the income gain. Note that this is quite a conservative assumption; typically, the marginal tax rate on additional income is much more than the average tax rate, often twice as much. We'll come back to this at the end of the analysis. The combined effect of the increased employment and the real income restoration is an increase in the tax base by a ratio of 1.05 / 0.92 = 1.14, or a 14% increase. Since we're looking for a 22% increase in the tax base, this means that we'll also have to increase the taxable proportion of income by 7%, based on the following equation: (1.14) * (1.07) = 1.22 It now remains to figure out whether this 7% increase is achievable with a capping of deductions in the $17,000  $50,000 range. I've put together a spreadsheet to figure this out. The short story is, this can be achieved by capping itemized deductions at $24,000, assuming tax bracket distributions from 2007: Taxable Taxable Taxable Fraction income income income Tax Income of tax Average without with percent percent bracket revenue income cap cap increase increase Top 0.1% 0.202 4423000 3896000 4399000 12.9 2.6 rest of top 1% 0.202 575000 488000 551000 12.9 2.6 2nd % 0.083 280000 232000 256000 10.3 0.9 3rd % 0.051 214000 175000 190000 8.6 0.4 4th % 0.038 182000 148000 158000 6.7 0.3 5th % 0.031 162000 131000 138000 5.3 0.2 rest of top 10% 0.107 130000 104000 106000 1.9 0.2 Total increase in taxable proportion of income 7 (some numbers may not multiply due to rounding) If we accounted for the fact that recovery of the 8% decline in income would result in recovery of much more than 8% in tax revenue, as mentioned in the discussion above, the deduction cap would be substantially higher. My bet is that Romney has accounted for that factor. And to take the speculation a bit further, I suspect that the $25,000 and $50,000 numbers he mentioned in the first debate are caps on the total of itemized deductions and personal exemptions for single and married filers respectively  and the $17,000 number is the cap on itemized deductions but not personal exemptions for single filers. That's certainly the ballpark I'd expect to be in if we accounted for the marginal effect of the income recovery properly. The bottom line is, yes, Romney's numbers do work out, with quite reasonable assumptions, and we can expect him to be able to cut taxes as claimed without reducing tax revenues. Source for tax revenue and income information: http://www.irs.gov/pub/irssoi/09in Source for tax deduction information: http://www.forbes.com/sites/baldwin/201 

For those who are skeptical of the "12 million jobs" claim, here's a graph that shows it can be done. The approximately 10% increase in jobs in two years of recovery from the 1981 recession would equate to over 14 million jobs today. http://www.heritage.org/research/report 
On November 6th, 2012 07:58 am (UTC), (Anonymous) commented: Much informative and useful article… I like it personally… 