Campaign 2008, Economics, Politics

Under Obama, Moving On Up May Be A Thing Of The Past

David Bernstein notes that the effect of the Obama tax plan would be to raise marginal tax rates above 50% and in some states it could be as high as 60%.

Obama is playing to his liberal type by exploiting the politics of envy to try and “soak the rich,” but in terms of actual policy, to do so would be economic suicide. It would encourage people to either A:) work less and be less productive or B:) shield their assets from taxation. (Or perhaps a combination of the two….)

The fact is that $250,000 is hardly filthy rich these days. The people that Obama will hurt with this punitive taxation will be the small business owners that employ 50% of the American workforce. They will be less inclined to grow their businesses and less inclined to hire new workers—because the marginal utility of the extra work just went down dramatically. If the benefit of working 10% harder is a 2% increase in income after Uncle Sam takes his bite, it makes little sense to work harder. Because of that, we lose the benefits of that extra labor.

The bottom line is this: it will become much more difficult for people in the middle class to move up the socioeconomic ladder. For Warren Buffet or Bill Gates, an army of lawyers and accountants can shield income while the boss pats themselves on the back for their “social responsibility.” For the average owner of a small flower shop or coffee house who can’t afford those kind of tax shelters, it means that moving to that next level is more of a curse than a blessing. For an economy that is based on the promise of upward mobility, such punitive taxation is anathema.

Obama’s plans make no economic sense. Instead of shoring up entitlements, he would dramatically expand them. For all of the talk about how McCain is a clone of Bush, Obama seems to want to take the worst policy ideas of the Bush Administration (Medicare Part D, steel tariffs, more government spending) and do more of it.

Obama is running as a doctrinaire Michael Dukakis-style tax and spend liberal. Even though this is unquestionably a Democratic year, a lot of voters will be smart enough to see that Sen. Obama seems to want to punish those with the audacity to hope to build themselves up economically.


Shrinkage Of A Different Sort

U.S. News‘ Capital Commerce blog notes the Democrats’ radical plan to skyrocket American tax rates. The Rangel plan would not only repeal the Bush tax cuts, but would create the largest tax hike in history, adding increased transaction costs to nearly every activity. The effect of such a reckless plan would be disastrous for the American economy. As economist and former White House advisor Lawrence Lindsey notes:

What’s more, if you eliminate the income cap on Social Security taxes—as some Democrats have proposed—Lindsey explains that “then we’re 60 percent.” The top tax bracket when Ronald Reagan took office in 1981 was 70 percent. Reagan then cut it down to 50 percent with the 1981 tax cuts and then to 28 percent with the 1986 tax reform package. “And remember,” Lindsey continued, “$200,000 was the cutoff for the 70 percent bracket back then, which would be like $400,000 today. And they would be taking the 60 percent bracket to income levels well under half that number.” Lindsey, who once wrote a fascinating book while at Harvard University about the Reagan tax cuts called The Growth Experiment, went on to joke that Dems were planning to run the “Shrinkage Experiment.”

The Rangel tax plan demonstrates the Democrats’ pathological love for raising taxes. It returns the death tax, it removes capital gains tax cuts, it raised taxes from the cradle to the grave. If it moves, the plan adds more taxes on it. (If it does nothing, there’s probably a subsidy involved somewhere.) It repeals over a quarter-century of growth-sustaining economic progress to return the country back to the days of stagflation and moribund economic growth.

Cutting the Alternative Minimum Tax (AMT) is not in itself a bad idea. Replacing it with equally misguided alternatives isn’t any better. The AMT phase-out can easily be offset by reductions in spending, corporate welfare, and subsidies. Unfortunately, Congress runs on spending, corporate welfare handouts, and wasteful subsidies.

America does not need higher taxes, it needs government that stops consuming all it sees. It needs less bureaucracy and more innovation. It needs an education system that actually works. It needs fewer roadblocks to saving and investment. Raising taxes not only doesn’t provide for those needs, it actually contradicts them. We don’t need more government spending, we need fiscal discipline in Washington. Giving Congress more money to play with is about as responsible as having Mark Foley lead a Boy Scout troop.

The Democrats keep proving that they’re one-trick ponies. The Rangel tax plan has been described as a wonderful gift for the GOP, which it would be if the GOP were smart enough to capitalize on it by tying the abolition of the AMT to reductions in wasteful spending and entitlement reform. However, that would take a measure of political courage, and no one in Congress seems to have that anymore.

We need a saner tax system in this country, one that does not punish productive economic activity. Saner does not equate to “more,” no matter what Rep. Rangel would think. The Democrats are once again showing their cards, and this is a warning sign to the country of what we could expect if the Democrats dominate in the 2008 election. The GOP needs to get a plan out there, push it hard, and set the tone for a more responsible fiscal agenda. Not only would that be good politics, but good policy as well.


The Shrinking Deficit

Megan McArdle observes that the national budget will be nearly balanced by the time George W. Bush leaves office, provided that current trends continue:

Thanks to George Bush’s amazing deficit reduction plan, the budget deficit is now only 1.2% of GDP. If this trend continues, by the time George Bush leaves office, the budget will be within a hair’s breath of being balanced. I can only hope that Democrats don’t squander this precious legacy of fiscal responsibility.

Just kidding! Not about the budget deficit, I mean, but about the reason for it. The reason the budget deficit has closed is a combination of economic growth and increasing inequality, which has allowed the government to collect more revenue on a smaller base. The rich really are different–they pay higher tax rates.

McArdle argues that it’s not Presidential policy that drives these changes, but larger macroeconomic factors. While that’s certainly true to a point, I don’t think that one can dismiss the role of Bush’s tax policies in driving those two factors of economic growth and income. The economic growth of the past few years has come in spite of the collapse of Enron and WorldCom, in spite of the aftereffects of the September 11 attacks and in spite of high oil prices. There’s a very strong argument to be made that the last few years of economic growth are attributable to a national policy of low taxes encouraging productive investment. That isn’t the whole story, but it is a very crucial part of why these last few years have seen solid levels of economic growth.

It’s also interesting that the standard Democratic argument against the Bush tax cuts is that they reduce the tax burdens on the rich. Yet the empirical evidence suggests that the tax burden is shifting the opposite way. Ms. McArdle is correct: the tax base is shrinking, and more is being gathered from a smaller subset of the population. From an economic perspective, that’s helping fuel the reductions in the deficit. Politically, such a thing can foster a sense of entitlement and dependence which is unhealthy over the long term.

The evidence indicates that the Bush tax cuts did what they were supposed to do: increase economic growth and tax revenue. The fact is that in 2003 the Congressional Budget Office predicted $2,421 billion in income tax revenues for 2007. The predicted tax revenue for 2007 now is $2,574 billion. The deficit has decreased to 1.5% of GDP, which is lower than it has been for 24 of the last 30 years. Economic growth remains strong despite the sub-prime mortgage scare and the unemployment outlook for the last few quarters has been revised upwards to show continued job growth.

All the fundamentals are working, but the real problems are spending and entitlements. It won’t matter whether we’re running a deficit or a surplus when the bill for Social Security and Medicare comes due. None of the reduction in the deficit came from cuts in spending, with spending still increasing far above the rate of inflation. The looming entitlement crisis guarantees that any advances made in the next few years will be nothing compared to the liabilities incurred when the Baby Boomers start hitting retirement age. The priorities for the next administration must be in reigning in both the out-of-control levels of spending and the equally out-of-control levels of mandatory entitlement spending. If those problems aren’t fixed, none of the progress of the last few years will matter much.

UPDATE: Ramesh Ponnuru notes that tax cuts do lower overall revenue. I would argue that it is possible to have a tax cut that pays for itself, but that would require a much higher marginal rate than we’ve had in decades. The reason why the Bush tax cuts should get some credit for the surge in revenues is because of their collateral effects. One of the biggest sources of increased revenue was on strong corporate profits, and those can be attributed to a combination of low interest rates and tax policy that is conducive to new investment.

Ultimately, federal revenues are much more dependent on the overall health of the economy than on tax policy. Worrying about maximizing federal revenue is the wrong approach; the primary concern should be in maximizing overall economic growth. The Democrats tend to obsess over the former, while the Republicans look to the latter. Tax cuts won’t necessarily bring an economy out of recession by themselves like some Republicans claim, nor will they cause one as some Democrats claim. Monetary policy has a big impact, as does productivity, the balance of trade and other factors large and small.

That doesn’t mean that tax cuts aren’t sound policy—they most certainly are, but the case that tax cuts by necessity pay for themselves isn’t the strongest.