"Rearview Mirror"

The Truth About Obama's Tax Plan

The Candidates on Taxes

The "Straight Talk Express" Has Derailed

This is damning to a candidate who allegedly provides the American people with nothing but "straight talk."

Country Club Economics

John McCain once told us that “the issue of economics is not something I’ve understood as well as I should.” Well, that much is clear. After all, how could he explain the inconsistencies between his rhetoric and the policies he advocates?

At every campaign stop, McCain is quick to tell adoring crowds that he would usher in a fiscal discipline that would put us quickly back on the path toward balanced budgets. It’s not clear how he plans to honor these promises but, if we look at his words, we must assume that ridding the budget of earmarks would be at the top of his list. In fact, it has almost become a holy crusade for him – a self-proclaimed maverick fighting valiantly to abolish the “pork-barrel projects” that slowly tear away at the soul of our government and undermine the trust of our citizens. For those bold enough to slip an earmark or two in legislation while McCain is President, he threatens: “I will make them famous and you will know their names.”

When one looks at reality, this bizarre obsession becomes more and more absurd. While acknowledging the inconvenient fact that earmarks (which were so shamelessly embraced by his running mate until recently) make up less up less than 1 percent of the federal budget, it’s also important to look at what they actually are. Technically, earmarks are provisions in law that direct approved funds to specific projects. Is there waste involved? Of course, there is. “Waste” is in the eye of the beholder but it’s tough to argue that there are many parts of the budget that could not use some trimming or efficiencies. And yes, there are often “bridges to nowhere” and funds directed toward questionable projects that get slipped mischieviously into legislation. That's why earmark reform should require a greater deal of transparency. At the same time, earmarks often provide much-needed funding for projects and programs such as child advocacy centers that provide care for sexually abused children or literacy programs that help low-income rural children learn how to read. Just because certain funding is “earmarked”, does that make it corrupt pork-barrel spending? If so, would you rather have, instead of your Members of Congress, unelected bureaucrats in Washington prioritizing the funding needs of your district and states?

The more inexplicable aspect of John McCain’s economic policy is that, while waging a crusade against earmarks, he has no problem with spending over $10 billion per month in Iraq when the Iraqi government has a budget surplus of nearly $80 billion. To compound the hypocrisy, he also supports the Bush tax cuts that have hampered our economy. Yes, the same cuts he once criticized for being too overly-generous for the wealthy. It’s a shame that he’s now blatantly pandering to that same population at the expense of middle-class working families.

So yes, it’s quite obvious that John McCain simply doesn’t understand economics. After all, his plan to balance the budget consists of “slashing” earmarks that make up less than 1 percent of the budget while dumping tens of billions of dollars into the pockets of millionaires and hundreds of billions into a war with no end in sight (if you follow his rationale).

For the Center on Budget and Policy Priorities, Richard Kogan and Gillian Brunet recently provided a better look at “How Projected Surpluses Became Deficits.” Was it earmarks? Not so much. It was tax cuts and increases in national security spending.

Impact of Tax Cuts and Spending Increases on the Budget for Fiscal Year 2009

As noted, tax cuts and program increases enacted by Congress have worsened the budget by about $1 trillion in 2009. (These figures assume that tax and program policies in place today will be continued.) As shown in Figure 1, the key components
are:

Tax cuts. Enactment of the 2001 and 2003 tax cuts, along with AMT relief, the normal “tax extenders,” and a variety of minor tax provisions have worsened the 2009 budget by $427 billion and thus account for 42 percent of the $1 trillion deterioration. These figures include both the direct costs of the tax cuts and their associated interest costs. (By reducing projected revenues, the tax cuts have increased deficits and debt relative to the January 2001 projection. With higher debt, the Treasury must pay more interest.)

Increases in appropriations for defense, international affairs, and homeland security. Expenditures projected for this portion of the budget in 2009 are much higher than CBO projected in early 2001. While a substantial portion of the extra costs stem from the wars in Iraq and Afghanistan, there have also been significant increases in the underlying budgets of the Departments of Defense, State, and Homeland Security that are not directly related to these wars. Total increases in this part of the budget amount to $399 billion in 2009, relative to CBO’s projection, and thus account for 40 percent of the $1 trillion deterioration, when the associated interest costs are included.

Increases in entitlement programs. Since 2001, Congress has enacted a number of entitlement increases, most notably the Medicare prescription drug benefit, but also increases in farm and nutrition programs, military retirement and health care, veterans’ education benefits, and other, smaller programs. These cost increases amount to $119 billion in 2009, or 12 percent of the $1 trillion deterioration.

Increases in appropriations for domestic, or non-security, programs. Funding for this portion of the budget has also increased above the levels projected in 2001, although this funding peaked in real terms in 2004 and has generally declined since then. The largest increases have occurred in education programs, veterans’ health care, and transportation programs. The increased expenditures in this part of the budget total $66 billion in 2009, or 6 percent of the $1 trillion deterioration.

As can be seen, tax cuts and defense/security increases account for 82 percent of the budget deterioration in 2009 that is attributable to legislation enacted since January 2001. Increases in domestic spending account for 18 percent.

Impact of Tax Cuts and Budget Increases Over the 2002-2011 Period

Tax cuts and program increases enacted by Congress have worsened the budget by almost $7.2 trillion over the entire 2002-2011 period, an average of almost $720 billion per year. (As noted above, these figures assume that tax and program policies in place today will be continued) As Figure 2 shows, the key components are:

Tax cuts. The 2001 and 2003 tax cuts and other tax provisions listed earlier will increase deficits by more than $3.3 trillion over the ten-year period, accounting for 46 percent of the $7.2 trillion deterioration. These figures include both the direct costs of the tax cuts and their associated interest costs.

Increases in defense, international affairs, and homeland security. These increases total almost $2.7 trillion over the ten-year period, or 37 percent of the $7.2 trillion deterioration, when the associated interest costs are included.

Increases in entitlement programs. These increases, plus the associated interest costs, total $745 billion over the ten-year period, or 10 percent of the $7.2 trillion deterioration.

Increases in domestic (or non-security) discretionary programs. These increases, plus the associated interest costs, total $456 billion over the ten-year period, or 6 percent of the $7.2 trillion deterioration.

Tax cuts and defense/security increases account for 83 percent of the budget deterioration over the 2002-2011 period that is attributable to legislation enacted since January 2001. Domestic spending increases account for 17 percent. In sum, tax cuts, increased defense and security funding, and a dose of economic cold water are, in order, the three key reasons that the large surpluses projected in January 2001 turned into substantial deficits. Increases in domestic programs have been relatively modest in comparison.

The federal budget is projected to run a $546 billion deficit in 2009, compared with the $710 billion surplus that budget experts projected for 2009 back when President Bush took office nearly eight years ago. This $1.3 trillion deterioration in the nation’s fiscal finances for 2009 can be seen by comparing estimates that the Congressional Budget Office (CBO) released this week with those that CBO released in January 2001.

The story is much the same for the entire ten-year period covered by CBO’s 2001 projection. In January 2001, CBO projected a cumulative $5.6 trillion surplus for 2002-2011. Now, CBO’s new report suggests the nation will amass a cumulative deficit of $3.8 trillion over that same period, marking a $9.4 trillion deterioration.

For both 2009 and the ten-year period, this massive deterioration is partly due to weaker-than-expected performance of the economy, along with other “technical” factors that are beyond policymakers’ control. But these economic and technical factors account for less than one-fourth of the fiscal deterioration for each period, and they are not responsible for the return of deficits. Even given the disappointing performance of the economy since 2001 relative to CBO’s earlier projections, there would have been large surpluses in every year — totaling $3.4 trillion over the 2002-2011 period — if policymakers had enacted no tax cuts or program increases since 2001.

The dominant factor in the unprecedented fiscal deterioration thus was not the performance of the economy. Nor was it increases in domestic programs. The key factors have been large tax cuts and increases in security-related programs. For fiscal 2009, some $1 trillion of the $1.3 trillion deterioration in the nation’s fiscal finances stems from policy actions, and tax cuts account for 42 percent of this $1 trillion deterioration. Increases in military and other security programs account for another 40 percent of the deterioration.

The story is much the same for the ten-year period as a whole. For the 2002-2011 period, tax cuts and increases in security programs account for more than four-fifths of the fiscal deterioration caused by policy actions. Increases in domestic programs played a much more modest role.

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.

Misconceptions about Small Businesses and Taxes

The Center on Budget and Policy Priorities (CBPP) recently released an interesting report on the “Big Misconceptions about Small Businesses and Taxes” that are perpetuated by Bush-McCain Republicans in their quest to widen income disparities even further and consolidate our nation's wealth in even fewer hands.

Supporters of various tax benefits for high-income households often claim that failure to maintain them would have an undue effect on many small businesses. But even assuming a broad definition of “small business,” such claims are often exaggerated or false. This paper examines three such claims.

First, critics charge that allowing the 2001 tax cut’s reduction in the top two marginal income tax rates for individual taxpayers to expire as scheduled would affect a large proportion of small-business owners. In fact, only 1.9 percent of filers with any small-business income are projected to face either of the top two income tax rates in 2009. By contrast, more than 14 percent of filers with small-business income claim the Earned Income Tax Credit (EITC) for low-income workers. Thus, strengthening the EITC could help more than seven times as many small businesses as reducing the top income tax rates.

Second, critics often greatly exaggerate the burden of the estate tax on small businesses. Only a tiny proportion of the few estates that pay any estate tax have significant small business or farm assets. Furthermore, the small businesses and farm estates that do pay estate tax benefit from special provisions designed to help them reduce their estate tax liability.

Third, critics often falsely claim that proposals to eliminate tax breaks for hedge fund managers would harm “mom and pop” businesses. Even the most expansive definition of a small-business owner does not fit the typical hedge fund executive.

This paper analyzes these claims. It likely overestimates the number of small businesses adversely affected by changes to the top two marginal tax rates, the estate tax, and loopholes available to hedge-fund managers because it: adopts an extremely generous definition of “small business” and does not consider many valuable tax breaks that small businesses and small-business owners enjoy. Yet it still finds that the claims typically made about small businesses and taxes are highly exaggerated, misleading, or false.

Bearing No Burden

In a recent editorial, the Washington Post hammers away on the notion that any tax increase on the wealthiest Americans - those taxed at the top marginal rate - is harmful for the economy.

The notion that a country at war should ask its citizens to bear the burden of higher taxes is now viewed in many quarters as quaint, if not ludicrous. In fact, rather than shared sacrifice, the watchword since the inception of the war in Iraq has been shared bounty: For the first time in U.S. history, taxes have been cut during wartime. The House of Representatives, to its credit, voted to pay for a small slice of war costs -- increased educational benefits for returning veterans -- with a small tax on the wealthiest Americans. Under the House measure, the tax rate for individuals earning more than $500,000 annually, or couples earning more than $1 million, would have risen by one-half of one percentage point.

Of course, this was anathema to congressional Republicans and the Bush administration. "A tax increase would be harmful to jobs and economic growth, and the President has been clear that tax increases are unacceptable," the administration said in its statement on the measure. "If the bill presented to the President contains a tax increase, he will veto it." It was also a non-starter in the Senate, where Democrats didn't even bother to press the issue when they took up the war spending bill. The likelihood is that the House will accede to the Senate's more spendthrift ways.

But as the costs of war mount, it's worth considering the arguments against paying for even a piece of them. Harmful to jobs and economic growth? Those who are lucky enough to have been asked to pay this extra tax constitute a minuscule fraction of American taxpayers, three-tenths of 1 percent. They would have had to ante up, on average, an additional $8,770 in taxes, according to calculations by Citizens for Tax Justice. As a result of the Bush tax cuts, this group has reaped an average savings of $126,690. Hard to see how asking these folks to give just a smidgen of that back, to finance the educations of those who might otherwise have no way of joining their ranks, would cripple the economy.

One particularly specious argument against this provision was that it would hammer small businesses that are the engine of economic growth, since many small businesses pay taxes at the individual income tax rate. House Republicans, inveighing against the measure, contended that it was a massive tax increase on small businesses because 82 percent of returns in this bracket contain small-business income.

As the Brookings Institution's William G. Gale showed in dispensing with this claim several years ago, only 1.3 percent of taxpayers with small-business income fell into the group taxed at the top marginal rate of 35 percent, which applies to incomes of more than $357,700. Furthermore, small-business earnings accounted for only one-third of income for taxpayers in that bracket. Especially at the highest income levels, these are not necessarily small-business owners but wealthy individuals who may do some consulting or real estate investing on the side.

These sorts of ad hoc tax hikes to finance ad hoc costs are not the optimal way to construct tax policy. It would be better to fashion a system that would bring in enough revenue to pay for the demands of government, accompanied by debates about how the tax burden should be distributed and how to prioritize needs. In addition, soaking the extremely rich cannot be the answer to every financing dilemma. At some point, tax rates, whether on small-business owners or ordinary individuals, can become so burdensome as to be counterproductive. But the country is not at that point. It is a sad commentary that even the smallest tax increase, even for the noblest purpose, is now automatic veto bait.