Monday, September 08, 2008

Obama Economics

In the Times, David Leonhardt explores both the economic policy and ideology of Barack Obama. As he contends, “[John McCain’s economic vision] amounts to a slightly altered version of Republican orthodoxy, with tax cuts at the core. Obama, on the other hand, has more-detailed proposals but a less obvious ideology.” An excerpt:

The most tangible way that today’s economy feels unfair is the lack of real income growth for most families. Earlier this year, when I interviewed Obama during the primaries, he was careful to say that he didn’t think President Bush deserved all that much blame for the stagnant incomes of the current decade. Income growth for most families began to slow in the 1970s, and the causes of the great pay slowdown were complex. Obama didn’t name them all, but a decent list would look something like this: new technologies that have made some blue-collar work obsolete; a slowing in the nation’s educational attainment; the shriveling of labor unions; the increase in one-parent families, which are far less economically secure; and the rise of other countries that have huge low-wage work forces.

What Obama blamed the current administration for, he said, was aggravating these trends with the tax code. To a large extent, Obama’s own economic agenda revolves around reversing Bush’s tax policies and then going a bit further in the other direction. Here, more than in his regulatory approach, Obama stands on the left side of the Democratic Party, but not exactly in the traditional tax-and-spend ways.

It’s helpful to start with a little history. When Reagan was elected, in 1980, tax rates on top incomes were so high that even liberal economists now say the economy was suffering. There simply wasn’t enough of an incentive for rich people to start new companies or expand existing ones, because so much of their profits would have gone to the federal government. Someone making the equivalent of $5 million in 1980 — in inflation-adjusted terms — would have paid a combined federal tax rate of almost 60 percent, according to research by Emmanuel Saez and Thomas Piketty, two academic economists. (These calculations cover not only income taxes but also payroll taxes, capital-gains taxes and others.) Reagan, by the end of his second term, had cut this rate to about 35 percent. Clinton raised it above 40 percent, but the current President Bush has reduced it to 34 percent. So over the same period that the rich have been getting much richer before taxes, their tax rates have also been falling far faster than the rates of any other income group.

Dating back to Reagan, Republicans have packaged tax cuts on high earners with more modest middle-class tax cuts and then maneuvered the Democrats into an unwinnable choice: are you for tax cuts or against them? Obama, however, argues that this is the moment when the politics of taxes can be changed.

To do this, he is proposing tax cuts for most families that are significantly larger than those McCain is offering, along with major tax increases for families making more than $250,000 a year. “That’s essentially a major part of our economic plan,” Obama said. “But it’s also a political message.” Economically, he is trying to use the tax code to spread the bounty from the market-based American economy to a far wider group of families. Politically, he is trying to drive a wedge through the great Reagan tax gambit. The Tax Policy Center, a research group run by the Brookings Institution and the Urban Institute, has done the most detailed analysis of the Obama and McCain tax plans, and it has published a series of fascinating tables. For the bottom 80 percent of the population — those households making $118,000 or less — McCain’s various tax cuts would mean a net savings of about $200 a year on average. Obama’s proposals would bring $900 a year in savings. So for most people, Obama is the tax cutter in this campaign.

If there is a theme to the Obama tax philosophy, it’s that the tax code is not quite as progressive as you think it is. Most of the public discussion about taxes tends to focus on the income tax, which taxes the affluent at a considerably higher rate than anyone else. But the income tax doesn’t take the biggest bite out of most families’ annual tax bill. The payroll tax does. And even as the federal government has been reducing income taxes over the last few decades, it has allowed the payroll tax, which finances Social Security and Medicare, to creep up. That’s a big reason that overall tax rates for the bottom 80 percent of earners have not fallen as much as rates for the affluent.

Obama’s second-most-expensive proposal, after his health-care plan, is the equivalent of a $500 cut in the payroll tax for most workers. (It is actually a credit that is applied toward income taxes based on payroll taxes paid.) In a speech this month in Florida, he proposed that the cut take effect immediately, in the form of a rebate, to stimulate the economy. For most workers, it would be the first significant cut in the payroll tax in decades, if not ever.

The other way that he would cut taxes involves a series of technicalities. But since the campaign began, Goolsbee has been arguing that those technicalities offer one of the best glimpses of how Obama thinks about the tax code. Right now, several big tax breaks that sound broad-based — like those for child care and mortgage interest — don’t always benefit middle-income and lower-income families. Another example is the Hope Credit for college tuition, a creation of the Clinton administration. Obama wants to more than double the credit, to $4,000. More to the point, he would make it “fully refundable.” As a result, a family with an income-tax bill of $3,000 wouldn’t merely have that bill eliminated; it would also receive a $1,000 check. Increasingly, the income-tax system becomes a way to transfer money to poor families.

All told, Obama would not only cut taxes for most people more than McCain would. He would cut them more than Bill Clinton did and more than Hillary Clinton proposed doing. These tax cuts are really the essence of his market-oriented redistributionist philosophy (though he made it clear that he doesn’t like the word “redistributionist”). They are an attempt to address the middle-class squeeze by giving people a chunk of money to spend as they see fit.

He would then pay for the cuts, at least in part, by raising taxes on the affluent to a point where they would eventually be slightly higher than they were under Clinton. For these upper-income families, the Tax Policy Center’s comparisons with McCain are even starker. McCain, by continuing the basic thrust of Bush’s tax policies and adding a few new wrinkles, would cut taxes for the top 0.1 percent of earners — those making an average of $9.1 million — by another $190,000 a year, on top of the Bush reductions. Obama would raise taxes on this top 0.1 percent by an average of $800,000 a year.

It’s hard not to look at that figure and be a little stunned. It would represent a huge tax increase on the wealthy families. But it’s also worth putting the number in some context. The bulk of Obama’s tax increases on the wealthy — about $500,000 of that $800,000 — would simply take away Bush’s tax cuts. The remaining $300,000 wouldn’t nearly reverse their pretax income gains in recent years. Since the mid-1990s, their inflation-adjusted pretax income has roughly doubled.

To put it another way, the wealthy have done so well over the past few decades, with their incomes soaring and tax rates plummeting, that Obama’s plan would not come close to erasing their gains. The same would be true of households making a few hundred thousand dollars a year (who have gotten smaller raises than the very rich but would also face smaller tax increases). As ambitious as Obama’s proposals might be, they would still leave the gap between the rich and everyone else far wider than it is now.

The Tax Policy Center's "Preliminary Analysis of the 2008 Presidential Candidates' Tax Plans" provides more analysis.

The two candidates' plans would have sharply different distributional effects. Senator McCain's tax cuts would primarily benefit those with very high incomes, almost all of whom would receive large tax cuts that would, on average, raise their after-tax incomes by more than twice the average for all households. Many fewer households at the bottom of the income distribution would get tax cuts and those whose taxes fall would, on average, see their after-tax income rise much less. In marked contrast, Senator Obama offers much larger tax breaks to low- and middle-income taxpayers and would increase taxes on high-income taxpayers. The largest tax cuts, as a share of income, would go to those at the bottom of the income distribution, while taxpayers with the highest income would see their taxes rise.

The impact of the tax code on economic activity under each candidate's policies would differ in several important ways. Under Senator McCain's proposed policies, the top marginal rates (35 percent on individual income and 25 percent on corporate income) would be significantly lower than under Senator Obama's plan (39.6 and 35 percent, respectively). McCain's reduced individual and corporate rates could improve economic efficiency and increase domestic investment, but the larger future deficits would reduce and could completely offset any positive effect. In contrast, Senator Obama's proposed new tax credits could encourage desirable behavior, particularly if the childless EITC and payroll tax rebate encourage additional labor supply among childless low-income individuals. However, he would also direct new subsidies at an already favored group-seniors -and an already favored activity-borrowing for housing-which could probably be better directed elsewhere.

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