This piece combines my two September, 2008 op-eds in Wall St. Journal
A CLOSER LOOK AT OBAMANOMICS
Michael J. Boskin
Michael J. Boskin is T.M. Friedman Professor of Economics and Hoover Institution Senior Fellow,
Stanford University, and former Chairman of the President's Council of Economic Advisers.
If I told you that a prominent global political figure in recent months has
proposed abrogating key features of his government's contracts with energy
companies; unilaterally renegotiating his country's international economic
treaties; dramatically raising marginal tax rates on the "rich" to levels not seen in
his country in three decades, which would make them among the highest in the
world; and changing his country's social insurance system into explicit welfare by
severing the link between taxes and benefits; the first name that came to mind
would probably not be the possible next President of the United States, Senator
Barack Obama.
Despite his obvious general intelligence and uplifting and motivational
eloquence, Senator Obama reveals this startling economic illiteracy in his policy
proposals and economic pronouncements (on this, of course, he is not unique
among candidates and Presidents). From the property rights and rule of
(contract) law foundations of a successful market economy to the specifics of tax,
spending, energy, regulatory, and trade policy, if the proposals espoused by
candidate Obama ever became law, the American economy would suffer a
serious setback. To be sure, Senator Obama has been clouding these positions
as he heads into the general election; and, once elected, presidents sometimes
see the world differently than when they are running, either forced to by events or
by the perspectives and responsibilities arising from the presidency. Some cite
President Clinton's move to the economic policy center following his Hillary
health care and 1994 Congressional election debacles as a possible Obama
model. But candidate Obama starts far further left on spending, taxes, trade and
regulation than candidate Clinton. A move as large as Clinton's toward the
center would still leave Obama on the economic left. Also, by 1995 the country
had a Republican Congress to limit President Clinton's big government agenda,
whereas most political pundits predict strengthened Democratic majorities in both
houses in 2009. Because newly elected Presidents usually try to implement the
policies they campaigned on, Senator Obama's proposals are worth exploring in
some depth. I'll discuss taxes and trade, although the story on other Obama
proposals is similar.
First, taxes. The table nearby demonstrates what could happen to
marginal tax rates in an Obama administration. Obama would raise the top
marginal rates on earnings, dividends and capital gains passed in 2001 and 2003
and phase out itemized deductions for high income taxpayers. He would uncap
Social Security taxes, which currently are levied on the first $102K of earnings.
The result is a remarkable reduction in work incentives for our most economically
productive citizens. The top 35% marginal income tax rate rises to 39.6%;
adding the state income tax, the Medicare tax, the effect of the deduction phaseout
and Obama's new Social Security tax increases the total combined marginal
tax rate on additional labor earnings (or small business income) from 44.6% to a
whopping 62.3%. People respond to what they get to keep after tax, which the
Obama plan reduces from 55.4 cents on the dollar to 37.7 cents, a reduction of
one-third in the after-tax wage! Despite the rhetoric, that's not just on "rich"
individuals. It's also on a lot of small businesses and two-earner middle aged
middle class couples in their peak earnings years in high cost-of-living areas.
(His large increase in energy taxes, not documented here, would
disproportionately harm low income Americans. And, while he says he will not
raise taxes on the middle class, he'll need many more tax hikes to pay for his big
increase in spending.)
I was among the many who originally took Barack Obama's statements
that he would "end the Bush tax cuts for the top incomes" too literally to mean a
return to the pre-Bush tax rates of 39.6% on ordinary income and 20% on capital
gains. The Obama campaign has now clarified that he proposes to do this for
labor earnings, but not for capital gains and dividends. I am told that Mr. Obama
would raise the rates to "no more than the Reagan rate," which apparently means
28%, from the current 15%. Senator Obama might thus raise the tax rate on
capital gains by about three time as much as President Bush cut it, but he'd
preserve at least some of the Bush reduction in the double-taxation of dividends.
The 28% rate on capital gains was the price President Ronald Reagan
paid to pass the 1986 Tax Reform Act that lowered the top marginal tax rate on
ordinary income (including dividends) to 28%. The capital gains rate was cut to
20% in 1997 under President Bill Clinton, and again to 15% in 2003. Mr. Obama
would thus give us the worst of both worlds: a top tax rate on wages (also
interest, rent and royalties) 40% higher than Reagan and a capital gains rate up
to 40% higher than Clinton.
Raising the rate on capital gains to 28% would greatly reduce the ability of
firms to minimize double taxation by returning cash to their shareholders through
share repurchases. Nearly doubling the tax rates on capital gains and dividends
to 28% is a terrible idea that would hit financial markets hard. After-tax returns to
equity investment would decline by almost 20%. And it will be much harder for
our financial institutions to raise the capital they need to shore up their balance
sheets and start lending again, a vital link in restoring solid economic growth, if
the returns to that capital are taxed at much higher rates. Finally, even a modest
response of work and investment to their returns means that Senator Obama's
tax rates, sooner or later, would seriously damage the economy.
On economic policy, the President proposes and Congress disposes, so
presidents often wind up getting the favorite policy of powerful senators or
congressmen. Thus, while Senator Obama also proposes an alternative minimum
tax (AMT) patch, he could instead wind up with the permanent abolition of the AMT
proposed by the Ways and Means Committee Chairman, Charlie Rangel, D-NY, a
4.6% additional hike in the marginal rate with NO deductibility of state income taxes.
Marginal tax rates would then approach 70%, levels not seen since the 1970s and
among the highest in the world. The after-tax return to work – the take-home wage
for more time or effort – would be cut by more than 40%!
Next, trade. In the primaries, Senator Obama was famously protectionist,
claiming he would rip up and renegotiate the North American Free Trade
Agreement (NAFTA). Since its passage (for which former President Bill Clinton
ran a brave anchor leg, given opposition to trade liberalization in his party),
NAFTA has risen to almost mythological proportions as a metaphor for the
alleged harm done by trade, globalization, and the pace of technical change.
Yet since NAFTA was passed, and relative to the comparable period prior
to its passage, manufacturing output grew more rapidly (and reached an all-time
high last year); the average unemployment rate declined (as employment grew
24%); real hourly compensation in the business sector grew twice as fast;
agricultural exports destined for Canada and Mexico have grown substantially
and trade among the three nations has tripled; Mexican wages have risen each
year since the peso crisis of 1994; and the two bi-national NAFTA environmental
institutions have provided nearly $1 billion for 135 environmental infrastructure
projects along the U.S.-Mexico border.
In short, it would be hard, on balance, for any objective person to argue
that NAFTA has injured the U.S. economy, reduced U.S. wages, destroyed
American manufacturing, harmed our agriculture, damaged Mexican labor, failed
to expand trade, or worsened the border environment. But perhaps I am not
objective, since NAFTA originated in meetings James Baker and I had with Pepe
Cordoba, Chief of Staff to Mexico's President Salinas, early in President George
H. W. Bush's administration.
Obama has also opposed other important free trade agreements,
including those with Colombia, South Korea, and Central America. Obama has
spoken eloquently about America's responsibility to help alleviate global poverty,
even to the point of saying it would help defeat terrorism; but he has yet to
endorse, let alone forcefully advocate, the single most potent policy for doing so,
a successful completion of the Doha round of global trade liberalization. Worse
yet, he wants to put restrictions into trade treaties that would damage the ability
of poor countries to compete. And he seems to see no inconsistency in his
desire to improve America's standing in the eyes of the rest of the world and
turning his back on more than six decades of bipartisan American presidential
leadership on global trade expansion. When trade rules are not being improved,
non-tariff barriers develop to offset the liberalization from the current rules. So no
trade liberalization means creeping protectionism.
History teaches us that high taxes and protectionism are not conducive to
a thriving economy, the extreme case being the higher taxes and tariffs that
deepened the Great Depression. While such a policy mix would be a real
change, as philosophers remind us, change is not always progress.
NOTE:
The article above combines my two Wall Street Journal op-eds (July 29 and
August 4, 2008) on Obamanomics. In what is now his fourth tax plan, Senator
Obama has subsequently lowered his proposed tax rates on dividends and
capital gains to 20%, a hike of 33 1/3% over the current rate of 15%. This
compares to his year-long campaign to "end the Bush tax cuts for the rich,"
widely interpreted as returning to the pre-Bush rates of 39.6% for wages and
dividends and 20% for capital gains. He then said he would raise the rates on
dividends and capital gains to "no more than the Reagan rate," which was 28%
after the 1986 Tax Reform Act, which also reduced the top tax rate on ordinary
income, including wages, to 28%.
Mr. Obama also campaigned on "uncapping Social Security taxes, currently
12.4% on earnings capped at $102,000. He later amended that to say the
uncapping would only be for those with income above $250,000. He now says
he will levy an additional tax rate of 2-4% on such earnings, not the 12.4%.
Thus, to calculate the current Obama tax plan's combined tax rates and after-tax
returns to work and investment, these new rates should be substituted in the
formulas in the table above, and likewise if the plan changes again. Also,
Senator Obama proposes large spending increases and a pay-as-you-go rule for
the budget in which all spending would be matched by cuts in other spending or
tax increases. So Senator Obama appears to have an implicit large additional
tax hike he has not specified. Senator Obama also says he will make Social
Security solvent in the long run, be honest about its problems, not raise the
retirement age, and look first to payroll taxes to solve the solvency problems.
Since his 2-4% hike on those with incomes over $250,000 would close only a
small fraction of the deficit caused by rapidly growing real benefits, he would also
appear to have a large, general payroll tax hike implicit in his policy.
Finally, Mr. Obama's claim that his proposals are a net tax reduction relies on his
counting the refundable parts of his many new and expanded refundable tax
credits as tax reductions, rather than outlays as is done in the federal budget.
Under this scoring convention, a large tax increase on taxpayers, the proceeds of
which were paid out to people who paid no tax, would count as neither taxes nor
spending.
Obama's Tax Policies
Marginal Tax Rate On Earnings Current Obama
Top Federal Rate 35.0% 39.6%
+ State Income Tax Rate (California) 10.3% 10.3%
+ Phase Out Of Itemized Deductions 1.2%
= Combined Marginal Rate Net Of Any Deductibility (t) 41.7% 47.0%
+ Medicare Tax 2.9% 2.9%
+ Additional Social Security Tax above $250,000 12.4% a
= Combined Total Marginal Tax Rate (t) 44.6% 62.3%
After-Tax Return Per Dollar Of Earnings (= 1-t) 55.4% 37.7%
Percentage Change -32.0%
Marginal Tax Rate On Dividends And Capital Gainsb
(Capital Gains Not Related To Corporate Income In
Parentheses)
Corporate Rate 35.0% 35.0%
Federal Rate: Ordinary Income 35.0% 39.6%
Dividends/Capital Gains 15.0% 28.0% c
State Income Tax Rate 10.3% d 10.3% d
Phase-Out Of Itemized Deductions - 1.2%
Combined Marginal Rate e 49.1% (21.7%) 58.0% (35.4%)
After-Tax Return Per Dollar 50.9% (78.3%) 42.0% (64.6%)
Percentage Change -18.1% (-17.5%)
a. Under the Obama plan, the additional Social Security tax above $250,000 could be as high
as 12.4%. If Senator Obama states a different rate, adjust the figures.
b. Must be adjusted for the advantage of deferral and the disadvantages of limited loss offset
and no inflation indexing.
c. "No more than Reagan", which was 28%. If he states a different rate, plug new figure into
formula.
d. In California, capital gains are taxed at the ordinary income rate, 10.3%.
e. Equals corporate rate plus (one-corporate rate) times the sum of the other rates net of
deductibility.
OBAMA'S TRADE POLICIES
NAFTA Unilaterally renegotiate
CAFTA Voted "No"
COLOMBIA Against
SOUTH KOREA Against
DOHA ROUND Does not support
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