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How the 20% Cut Will Actually Work

Mitt Romney and Paul Ryan have made the central pillar of their campaign a promise that they can generate 12 million new private sector jobs by cutting all tax brackets by 20%. They also say they will cover the lost tax revenue by closing current loopholes that favor the wealthy. Neither of these will work. History, logic, human nature, and plain arithmetic all say these are unrealistically optimistic projections. It is much more likely this plan will lead to economic disaster.

It sounds reasonable that cutting a business’ income taxes by 20% would free up spending and encourage hiring. But that’s not how it works. The accounting system and the stock pricing system we have in place do not connect these dots. Paying less taxes directly raises profits. Shareholders like higher profits. In fact profits are one of two major measures of a company’s worth, which reflects in share price.

The other measure of worth is efficiency. How much do you spend to make your income? Adding employees lowers efficiency. This is why companies that are struggling cut employees even though that means less work being done. Lowering payroll gives a company room to reorganize and try to stay afloat with what’s left.

So taking the savings from a big tax break and using it to hire more people negates the increase in value from the higher profits. The company is producing more and earning more, but it isn’t worth more. Shareholders don’t see any higher return on their investment even though the company got this big tax break.

We have startlingly clear evidence of this in our recent history. In California in the mid-1970’s there was a “tax revolt” by homeowners who felt the state government had plenty of money to run the state without collecting high property taxes. So the people used the state’s initiative system to put it to a vote. Proposition 13 passed and lowered all property taxes to 1% of at-sale assessed value. One of the expected benefits of Proposition 13 was that with lower taxes, landowners would pass the savings onto their business tenants, and those businesses would then be able to hire more people. More people working would mean higher income taxes collected, which would hopefully make up for some of the money lost in the property tax cut.

None of this happened. Landlords did not pass on their windfall to their business tenants. And those businesses who did renegotiate their leases (or move to lower rent facilities) did not use their savings to hire more employees. So the state’s income tax collection did not go up, and the money lost from the lower property taxes was not recovered. The state lost so much money it had to divert the state’s lottery money to cover education costs. Even with that diversion, the state’s public schools went from number 1 in the country to number 47 inside of 20 years.

So lowering everyone’s taxes by 20% will make it easier for us all to pay our bills, but there is ample evidence that it will not translate into job creation.

The Romney/Ryan ticket says the 20% tax cut will be paid for by closing loopholes that are used by the wealthy. This sounds like a reasonable place to get the money back, since the Left has made it sound like the wealthy take such unfair advantage of the tax system. So let’s look at how this would work.

If a wealthy person is currently using these “loopholes” (business deductions, capital gains, estate taxes, overseas shelters, trusts, etc.) to save 20% off their taxes, and Romney and Ryan are eliminating these breaks, but then giving this person, just like everyone else, a 20% cut in their overall income taxes, then our hypothetical wealthy person is going to see no net change in their tax bill.

So there is no additional money from the closure of the loopholes to pay for the 20% tax cut the rest of the county is getting.

If a wealthy person is saving more than 20% of their income taxes using these loopholes, then closing them could generate some additional money. This means a net tax increase to the wealthy. These loopholes were hard fought and won over generations. The wealthy are not going to stand by idly and watch their tax shelters eliminated. Each one that comes up for trimming in Congress is going to be fought over more fervently than when they were first instituted. Getting such cuts passed into law will require compromises and concessions that will take the bite out of the cuts. And every concession will mean that much less new money being collected to make up for the 20% across the board cut.

Any additional taxes the wealthy do end up paying will be passed on to consumers in higher prices. There is no reason to believe that at the end of the day the wealthy will not get the 20% tax cut, keep some of their loopholes, and be able to raise prices. Make no mistake, in a capitalist system, it is always the consumer who makes up any difference. (The Left would ask: Do you think Big Oil and Big Pharma would be backing the Romney/Ryan ticket if there was any chance of them having to take a net loss on the deal?)

And in the meantime, for the years while these loopholes are being fought over, the 20% tax cut will be paid for by adding trillions of dollars of new debt to the national budget.

If this pattern seems familiar, it should. Bain Capital and other asset reorganizing venture firms borrow large amounts of money to pay for big changes that are projected to make the company more profitable in the long run. If it works, everyone gets paid back and the company is better off. But often the reorganization does not work, and the company goes under carrying all the added debt. The venture firm loses nothing, they are just an agent, but the shareholders who believed in the venture firm’s plan get stuck with the bill.

This is exactly what is going to happen here. The tax cut is not going to generate the projected jobs, so no new income tax will be collected. The loophole closure is unlikely to generate much new tax collection, and that’s only for the loopholes that can be closed. Prices will rise. All the while the big tax cut will get covered with more debt than you can imagine. The credit rating and the value of the dollar will plummet. Our ability to trade overseas will dwindle. And with less trade, more jobs will be cut.

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