Obama’s Tax Plan
July 7, 2008
I am a Barack Obama fan — I’ll vote for him in November — but his tax plan, as presently conceived, is pretty ugly stuff. It is not only a marginal negative, but could add a whole new aspect of economic deterioration for the U.S., which is already struggling with monetary inflation and a credit breakdown. It will be interesting to see how this plays out in 2009 — interesting in the way a train crash is interesting.
Here’s a summary of what’s on the agenda (which could change):
1) Increase taxes on capital gains from 15% to 28% or even 35%.
2) Probably make dividends (now 15%) taxable as regular income again.
3) Raise the top income tax rate back to 39.6% from 35%.
4) Remove personal exemptions and deductions for those with income over $250,000.
5) Make income over $250,000 subject to Social Security taxes, of 15.65% (including both employee and employer contributions). This would make the effective top income tax rate over 56%. When adding various state and local income taxes, this would mean top income tax rates over 65% in places like California and New York.
6) A tax credit of $500 per person, to offset payroll taxes on the lowest-income earners
7) Eliminate income taxes for seniors making less than $50,000.
An economy can function reasonably well under high income tax rates, if the rates fall on high incomes. In 1965, for example, the top income tax rate was 70%, but you needed to make $100,000 (about $1,500,000 today) to pay that rate. We’re looking at rates near 70%, if the Social Security cap is eliminated (note that it was Bill Clinton that eliminated the corresponding cap on Medicare taxes), but on incomes of $250,000. In 1955, for example, the top income tax rate was 91% on incomes over $400,000, which is about $6,000,000 today. However, on incomes of $16,000 to $20,000 (about $240,000 – $400,000 today), the rate was 30%. Plus, payroll taxes (Social Security, Medicare didn’t exist yet) were much lower. The original Social Security tax rate was 2% (1% employee and 1% employer). This was raised to 4% (2%+2%) in 1956, and to 6% (3% + 3%) in 1961. The rate today is 15.30% (7.65% + 7.65%).
Capital gains taxes have some of the largest negative effects on an economy, since they so clearly obstruct the accumulation of capital which is so important for providing investment and good jobs for workers. We looked at the capital/labor ratio a few weeks ago:
These capital gains tax hikes are bad in any case, but potentially more so in an environment of inflation. The capital gains tax is not adjusted for inflation. When the dollar falls to $0.50, investments need to double in nominal terms just to keep pace with the inflation. This phantom “gain” is taxed at a high rate, thus eliminating that much more capital from the system.
Indeed, a capital gains tax hike is also a very “1970s” element, as Richard Nixon signed a big capital gains tax hike in 1969. This was eliminated in 1979, producing a rather nice boom in certain subsets of the economy.
Much the same applies to the income tax. One of the difficulties encountered in the 1970s was “bracket creep.” In 1970, the 70% tax bracket applied to income over $200,000, or almost $3,000,000 today. In 1979, the dollar’s value had fallen by about 10x, but the 70% rate still applied to income over $215,400. Today, tax brackets are automatically adjusted to the government’s CPI, but the CPI is such a fiction these days that we are rather close to having no inflationary adjustment at all. Thus, in effect we have a potential combination of both higher tax rates and bracket creep, which could be quite troublesome. We don’t know today how far this inflation will go. Ten years from now, the highest tax bracket and its 65%+ effective rate might apply to the equivalent of $50,000 today.
The giveaways for lower-income workers are fine, but wouldn’t have much economic effect besides the welfare aspect. The $500 “tax credit” is essentially the same as the $600 check-in-the-mail that the government is presently handing out. Nevertheless, I support lower taxes for lower incomes. This is something that the Republican types have missed, I think. They have wanted to focus their tax-cutting efforts on the part of the tax code which has the most dramatic negative effects — high income tax rates and taxes on capital. However, by doing so, they have justifiably been criticized for ignoring the lower income workers. I think they would find more political support if they cut taxes for everyone at the same time. Obama’s plan to make $50,000 of income tax-free for seniors is fine, but I would expand it to all taxpayers. Give everyone a $50,000 basic deduction. (Or $20,000 per adult and $10,000 per kid.) Taxes paid by households with less than the median income (about $48,000 if I recall) account for only about 4% of income tax receipts, and of course an even smaller portion of total tax receipts.
The idea that the “distribution of income” can be resolved by high taxes on capital doesn’t work well in practice. One of the reason that some European systems have worked passably well is that taxes on capital and corporations are low, which allows more capital accumulation, which provides the investment for a broader middle class. Germany, Japan, Singapore and Korea traditionally have not taxed capital gains at all. Nothing particularly bad happened. In fact, something good happened — these capital-rich environments have plenty of good jobs available.
After raising taxes all over the place, much of the rest of Obama’s “economic plan” (mostly it is a collection of irrelevancies that would have little economic effect) consists of — tax credits! Tax credits for manufacturing, for children and dependents, for mortgages, for colleges, for clean technologies, for “locally owned biofuel refineries,” and for R&D.
In practice, usually governments (and even venture capitalists for that matter) have little idea what the next avenue for economic expansion will be. The personal computer was poo-poohed when it was invented. So was the transistor, which engineers thought would be useful for hearing aids perhaps but would not replace the vacuum tube. It doesn’t have to be technological either — look at Starbucks’ coffee business. Making lattes is just as legitimate a business as hard drive manufacturing and airlines, and probably more profitable too. Coca-Cola has been a bigger homerun than all the DRAM manufacturing of the past 20 years. Maybe the nexus of future activity will be railroads! If you simply remove the barriers to investment and commerce in general — capital gains taxes or corporate taxes for example — then people are free to experiment with all sorts of things, and find out what works. This is a far better method than having a government bureaucrat try to guess that “locally owned biofuel refineries” (which are now going bust en masse due to higher corn prices) are the wave of the future. On a personal level too, if the first $50,000 of income was exempted from taxes, then people could spend their own money however they wish, on colleges, child care or whatever. For Democrats who are having trouble with this idea, you can think of it as a “tax credit for living.”
Of course, these are just plans and proposals at this stage. We could find that the electorate tries to block these tax hike plans by stuffing Congress with Ron Paul Republicans — in favor of lower taxes, no wars, and police state rollback. So, if you’re running for Congress this year as a Republican, that’s the platform I’d choose. If you’re running as a Democrat, you could adopt the same platform, come to think of it.
* * *
The amazing thing about hyperinflation in Zimbabwe and similar cases, is that people even continue to use the currency at all. At some point long past, you’d have thought they’d go to black market euros, or cigarettes, or sacks of wheat or copper pipe or cowrie shells or AK47 ammunition or whatever. I think this is illustrative of the degree to which people are caught up in the fantasy that prices in a collapsing currency have any meaning at all — the degree to which people continue to use money as a counting-unit even when it obviously is unsuited for the task. “The price of milk went up 1,000,000,000%!!!” Yeah, sure it did. Nothing at all happened to milk. The only difference is more paper. You’d think people would at least go to barter of some sort: I’ll work for eight hours in return for five gallons of diesel. Something like that. In which case, the “inflation rate” would be irrelevant, just a game someone is playing somewhere. Milk would be milk, diesel would be diesel, and the paper money would be losing value as usual — nothing new there.
We are still in the early stages of inflation in the U.S., but even later, when the inflation is perhaps more intense, people will tend to regard prices as changes in the value of goods, rather than the value of money. On Jim Puplava’s radio show last year, I said that we could see oil prices of $1,000 a barrel before this episode is over, within 6-8 years perhaps. (This seemed rather reckless at the time, when even the bulls were whispering about $100 oil, but I think that mainstream Wall Street analysts have talked about $500 oil in recent weeks.) Most of this would be simply a change in the monetary counting unit. Some of it would be due to “Peak Oil” issues. It would be $100/barrel oil, up 4x from the $25/barrel oil of the 1990s, but the dollar would be worth only $0.10 — or 1/3,500 oz. of gold, from 1/350 in the 1990s. I still think that could happen (though oil is due for a correction in the short term). Most people’s eyes would bug out of their heads, but what did you think was going to happen when the dollar goes to $0.10? In the 1970s, oil went from $2.50 to $40. Nobody asks why it didn’t go back to $2.50 afterwards, but stabilized around $25 or so. Maybe I should say: when the dollar goes from $0.10 to $0.01. At $18 silver, my 90% silver dimes from the 1950s are worth about $1.26 each today. Apparently, the dollar is already worth less than $0.10!
* * *
The Daily Reckoning was kind enough to publish an essay: “The Volcker Myth“