Over the next few days, I’ll be writing a series of posts examing the likely effects of McCain’s and Obama’s tax proposals in detail. I’ll be using the Tax Policy Center’s numbers for projected effects for several reasons:
- It seems to be a thorough analysis from a non-partisan source.
- It’s widely cited by Obama supporters, so they can hardly object to it being cited by an Obama opponent.
- Detailed information is easily available about below-the-headline information, which is what I want to dig into.
- Enough information is available about their methodology for me to agree with or quibble with it as appropriate.
Tax Policy Center is analyzing two versions of each candidate’s proposals: the tax policy described in their stump speeches, and the tax policy described by their economic advisors. I’ll be looking mainly at the stump speech versions, because:
- We’re electing the candidates, not the advisors (who may be fired or overruled at any time)
- If you can’t trust what a politician says in order to get elected, what can you trust?Â
Today, I’ll start by looking at the unfortuant side effect of tax cuts: they tend to bring in less revenue. TPC has detailed revenue estimates for McCain’s proposals and for Obama’s proposals. This analysis assumes a 0.25 elasticity of indivual income with respect to marginal tax rates (reflecting a moderate tendency to dodge taxes by working less or taking non-taxable benefits instead of raises) — this strikes me as a slight oversimplification, as income avoidance isn’t linear with respect to tax rates, and it isn’t constant with respect to income, but it’s probably not so much of an oversimplification as to invalidate the analysis, and it’s much better than a naive estimate that assumes people don’t respond to incentives by trying harder to dodge higher taxes.
The assumption that there will be no behavioral response to corporate income tax changes is a much larger oversimplification — it’s very likely that lowering our corporate income tax to match the weighted average of developed countries would bring in significant investment to the US that’s currently going overseas, raising taxable corporate profits, and creating jobs domestically that expand the tax base for the personal income tax. However, modeling how large that effect is would be very difficult to do well and could easily be attacked as an overly optimistic estimate. I don’t blame them for using a static estimate, but that means that we have to regard their revenue estimates for McCain’s proposals as a worst-case scenario.
McCain’s proposals would yield revenue between 15.7% and 16.3% of GDP over the next 10 years, averaging 16.1% of GDP. His revenue intake would be $338 billion/year ($3.4 trillion total) short of the baseline of extending the Bush tax cuts and the AMT patch indefinately.
Obama’s proposals would yield revenue between 18.2% and 19.0% of GDP over the next 10 years, averaging 18.4% of GDP. His revenue intake would be $102 billion/year ($1 trillion total) more than the baseline of extending the Bush tax cuts and the AMT patch indefinately.
The Congressional Budget Office projects federal spending over the same time period to be $39 trillion dollars. Obama’s tax proposals would raise revenues by 2.6% of projected spending, while McCain would cut revenue by 8.7% of projected spending. To be debt-neutral, McCain would need to reduce planned spending over the next ten years by 11.3% relative to Obama’s spending plan. McCain is talking up spending cuts, but he hasn’t gone deep into specifics — he’s a long-standing crusader against wasteful non-defense discretionary spending and is continuing to talk this up, but there’s only so much you can cut there. He’s also started to talk about reigning in the growth of entitlement spending, but he hasn’t gone into details there, either. There are ways McCain could cut spending, and I think based on his record as a Senator that he’d be likely to get significant spending cuts implemented as President, but I can’t analyze them without specific proposals.
Where we do have details as to how President McCain would spend less than President Obama is on new spending President Obama would call for but which President McCain would veto. The largest proposal, Obama’s health care plan, is a spending proposal that would offset his revenue gains, while McCain’s health care plan is implemented in the tax code (a refundable tax credit), so the cost is included in these revenue numbers. All together, the LA Times cites Obama’s campaign as estimating $130 billion/year in new spending (over ten years, 3.8% of projected current-law spending). That’s a campaign figure, but we’ll use it unless there’s a reliable analysis from a non-partisan source.
So beyond not implementing Obama’s spending proposals, McCain would need to cut planned spending by an additional 7.9% of planned spending in order to match Obama on the fiscal responsibility front. By CBO numbers, this would require cutting the planned growth of spending under current law by a third, from 4.7% a year to 3.5% a year. Tough (especially without an electoral mandate for specific spending cuts), but potentially doable.
{ 1 trackback }
{ 15 comments }
Kindly define "likely effects" and "details" ?
Obama has a track record of overseeing 150 million dollars spend on Chicago school improvements with zero education improvement in Chicago students.
His solution: Spend more money.
So what are "likely effects" ?
A couple of quick bullet-type points.
1. To address the objection before it’s raised, the Laffer curve has two sides. When the highest marginal income tax rate is well over 50%, you’re on one side of the curve and cutting taxes can actually increase revenue. When you’re where we are and the highest marginal income tax rate is under 40%, you’re on the other side of the curve and cutting taxes cuts revenue.
2. Our current fiscal situation is far from hinged.
3. If we cut 100% of earmarks, it would scarcely put a dent in the budget. Earmarks are a red herring.
4. Most of our federal expenses are Social Security, defense spending, and debt service.
5. The expense side is intractable.
6. You can’t believe anything that any Washington politician says about cutting spending.
7. There is no budget line item for waste, fraud, and abuse.
8. To bring sanity to our fiscal situation we’ve got to raise taxes.
9. And not increase non-Social Security, non-defense, non-debt service spending.
10. Health care is coming up fast.
Another point: I think it’s disingenuous to to distinguish between income tax policy and FICA. Sen. Obama’s plan to impose FICA on the income of the highest wage earners amounts to a whopping tax increase. Look up "deadweight loss".
Note that I believe that FICA max should be eliminated and FICA imposed on all wages. However, I think it should be done on a (nearly) revenue neutral basis, i. e. the employer and employee rates should be lowered when FICA max is eliminated.
I don’t think raising taxes without addressing the rate of growth of entitlement spending is a viable solution. The fundamental problem is that Social Security, Medicare, Medicaid, and SCHIP are growing faster than the economy and are projected to continue doing so indefinately. Part of the problem is a temporary but long-lasting demographics crunch (Baby Boomer retirements); if that were the only issue, we might be able to tax our way out of the hole. But more of the problem, especially for the programs other than Social Security, is that the per-benficiary costs are going up too quickly, and that’s a problem that won’t die off with the baby boomers.
If we continue to guarantee the rate of growth that current law implies for entitlement programs, then we will hit the peak of the Laffer Curve long before we tax our way out of our long-term insolvency. Also remember that it’s not just the peak of the Laffer Curve that we need to worry about, but the shoulder, where it requires a lot of tax increase and deadweight loss to get a little bit of extra revenue. We’re definitely on the upward-sloping side of the Laffer Curve, but we’re probably pretty close to the shoulder and potentially past it already.
It should be noted, however, that I’m not predicting catastrophy. It’s been observed that if something can’t go on forever, it won’t. My worry is that the longer we wait before addressing the underlying issue, the more painful it will be to address it.
The Tax Policy Center numbers appear to treat Obama’s proposed FICA increase as a tax increase, which is as it should be.
Social Security and Medicare (the two main culprits) need not be treated the same way. Social Security can remain solvent forever as long as a balance is retained between incomes and outlays. No, it’s not a Ponzi scheme.
The problem with Medicare is that health care is too expensive. Simple as that. Health care costs have been rising at a multiple of the non-health care rate of inflation for nearly 50 years and faster than salaries for nearly that whole period.
The problem is thorny enough that I decided to devote one part of my series just to health care (even though it could reasonably have been included in fiscal policy).
"likely effects" and "details"Â went unanswered.
Okay, Â let us try some facts n’ stuff :
The real Barack Obama on Taxes
McKiernan — I made up my mind long ago that I strongly prefer McCain to Obama, so my instinct (confirmation bias) is to be overly charitable to McCain and overly critical of Obama. I’m making a conscious effort to balance that by giving Obama the benefit of the doubt in this analysis wherever possible.
Dave, Social Security may not be strictly a Ponzi Scheme, but it does have some big similarities, most notably that the bulk of its outpayments come directly from the revenue inflow. The key difference is that Ponzi Schemes offer a rate of return so high that the promised benefits cannot be paid for more than a very short length of time. Social Security’s current benefits formula promises more benefits than can be paid with the current revenue scheme, although the point of insolvancy is a decade or three away (depending on whether you count from when the government starts needing to repay the money it’s been loaning to itself and spending, or when the IOUs run out). So we need to either fix the benefits formula (my preferred solution would be to index benefits to prices instead of wages), or raise taxes without raising benefits.
I absolutely agree that health care based entitelments are a larger problem than Social Security — on Social Security alone we could probably tax ourselves into solvency (I don’t think it’s desirable to do so, but that’s another debate), but on Medi* we can’t. There are various possible solutions to that — means testing of benefits, rationing and price fixing of health care, higher copays, major structural reform (towards a free market in health care, or towards socialized medicine), etc. I’m inclined to support a combination of higher copays and structural reform towads a freer market, but I’ll wait for your post before discussing in detail.
Eric, as a control, can you repeat your analysis on the Bush tax cust to predict what the effect on revenue would have been versus what the actually were?
(Im not clear enough on economic theory to know if there’s value in that experiment or not, but I am looking to be educated here. Your methodology seems sound to me, but I like controls in any experiment to "test the model")
Eric,
You’re free to give Obama the benefit of your doubt all you wish but Obama is still trying to jerk everyone else’s chain of credulity.
Aziz, that’s a fair question.
The Tax Policy center does have revenue analyses on their website for the 2001 and 2003 tax cuts:
http://www.taxpolicycenter.org/numbers/Content/PDF/JCX-51-01.pdf
http://www.taxpolicycenter.org/numbers/Content/PDF/JCX-55-03.pdf
They estimated the 2001 tax cut at $1.3 trillion over ten years, and the 2002 tax cut at $350 billion over ten years.
For test purposes, let’s look at the 2007 revenue estimates as they’re the most recent actual figures. They estimated that 2007 revenue would be $151 billion less due to the 2001 tax cut, and an additional $14 billion less due to the 2003 tax cut; total of $165 billion less.
From the CBO’s 2000 budget outlook:
http://www.cbo.gov/doc.cfm?index=1820&type=0&sequence=1
Estimated 2007 revenues were $2,572 billion.
Applying the TPC estimates as a diff gives a modified estimate of $2,407 billion.
Actual 2007 revenues (via the CBO link in the original post) were $2,568 billion. The methodology underestimated revenues by $161 billion, almost the entire projected cost of the tax cut for that year. I suspect most or all of that is on the CBO, not the TPC, as the CBO projects cautiously by design.
As for the obvious “Dude, where’s my surplus?” question, the CBO estimated $2.2 trillion in spending in 2007. Actual spending was $2.7 trillion. Without looking at the numbers in detail, I suspect that’s mostly Iraq and the Medicare Prescription Drug Benefit, with smaller but still significant contributions from Afghanistan and Katrina relief.
You’ll have to take my word for this because I wasn’t blogging at the time, but I voted against Bush in the 2000 primaries because I was afraid “compassionate conservative” meant he’d be extremely generous with the taxpayers’ money. If I’d done an analysis like this in October 2000, I’d likely have expressed worry that Bush would try to squander much of the rest of the surplus with new spending programs, but nevertheless I supported the tax cuts on their own merits and hoped congressional Republicans would hold the line on spending.
A tax cut of some sort was politically necessary in 2001 and 2003 and I think we should be more understanding about political necessity. After all, we’re the ones who make it necessary.
Unfortunately, they were the wrong tax cuts. The right tax cuts would have caused even more cross-aisle screaming.
I think it is very unclear where we are at on the Laffer Curve, but am open to being pursuaded – I just think that effects at that macro level are difficult to predict and even harder to assign cause. The economy is an incredibly complex system.
More importantly, I think another, sometimes overlooked aspect of tax cut/rate analysis, that is not captured by the Laffer Curve is that money in the hands of the private sector is used more productively (as they look to invest in the the highest, risk adjusted, returning project) than that in the hands of government (who can only redistribute wealth). This acts as a multiplier that, over the long(er) term, is very difficult to measure with regard to how much extra wealth it creates for society, which of course, grows the tax base as well as pushes some into a higher marginal tax bracket.
For that reason, it does not surprise me that actual revenue exceeded forecasted revenue in the wake of the Bush tax cuts. Historically, it is typically the case that cuts in taxes are followed by increases in revenue.Â
If I recall correctly, this proved to be so following tax cuts in the 20s, Kennedy’s cuts, Reagan’s and now Bush’s? (I’ll dig into this later, but I actually have to work just now.)
One more thing, in terms of budgeting, I just don’t trust Congress with a surplus. It seems to me that the only way to actually get a spending cut is to get a deficit that the populous will simply no longer tolerate.
Giving more money to those who (as an institution)Â have proven to be irresponsible spenders seems counter intuitive.
Comments on this entry are closed.