President-Elect Obama’s Tax and Stimulus Plans
During the presidential campaign, Barack Obama proposed a comprehensive tax plan that would raise taxes on high-income taxpayers, cut taxes for low- and middle-income households, and lose $2.9 trillion dollars of revenue over ten years. Obama will take office with the economy in sharp recession and a deteriorating fiscal situation, made worse by new spending on a bailout plan. Faced with those crises, Obama says he will pursue both his campaign tax plan and additional tax-related proposals addressing problems created by the downturn. This paper examines revenue and distributional effects of the tax plan and describes some stimulus proposals.
Great Expectations
I’ve been reading up on the Great Depression (never say those of us at TPC don’t know how to have fun) and am struck by one overriding thought: Even with the benefit of 80 years of hindsight, economists still can’t agree on either what went wrong or how the economy got back on track.
There is an important lesson here. Famously impatient, Americans not only expect government to fix today’s economic crisis, they demand it. Barack Obama, I suspect, will have about a year to turn things around before the public turns on him. Yet, if we still don’t know what happened in 1929, how can we expect policymakers to truly understand—and correctly address—events happening in real time today?
Here is the dirty little secret: Obama doesn’t know how to fix the recession. Nobody does. It is easy (though wrong) to say Herbert Hoover failed to grasp the enormity of the Depression. But in truth, FDR had little better idea of how to respond to the crumbling economy. In fact, Roosevelt was famous for trying one solution after another until something seemed to work.
There is broad agreement on what government should not do, such as run a tight monetary policy or restrict trade. But there is much less consensus on what it should do. How much will pulling fiscal levers boost demand? Is massive new government spending really such a good idea? Will tax cuts get people and businesses spending again?
When credit markets collapsed earlier this year, George Bush turned to his group of wise men for advice. They included Fed Chairman Ben Bernanke, a highly-regarded student of the Depression. President-elect Obama has now chosen his team, including Christy Romer, another expert on that era. They are very smart, and have access to far better data than their counterparts had in the 30s.
But today’s data are not that good. And there is no magic bullet. For instance, Treasury Secretary Hank Paulson has been roundly criticized for his on-again-off-again use of the TARP. First, he insisted on using the $700 billion to acquire bad assets, then he decided to pump liquidity into financial institutions, and now he is giving $13 billion to the auto companies. This seems incoherent because it is. But trial-and-error is as inevitable in economics as in medicine—another field based more on art than science.
Obama’s stimulus plan, which by some accounts will cost $850 billion or more, will include its share of bad ideas. Some initiatives may at first seem to make perfect sense but will inevitably have dreadful unintended consequences. And there will be good ideas that should be in the plan but fail to make the cut.
Those of us who kibbitz from the sidelines will identify mistakes and demand better alternatives. But we should have no illusions. Getting a huge, complex, and still poorly understood economy back on track is not going to be simple and it will take time. Obama, despite the stratospheric expectations he’s raised, is going to make errors. We will, and should, call him on those poor choices. But we’d be fools to expect perfect diagnosis and treatment from the incoming Administration.
Breaking News: Higher Energy Prices Will Cut Demand
Nice to see Tom Friedman on the energy tax bandwagon. As he wrote in his Dec. 27 New York Times column, “I’ve wracked my brain trying to think of ways to retool America around clean-power technologies without a price signal—i.e., a tax—and there are no effective ones.”
Friedman needs to give his cranium a holiday break. Policymakers have been searching for this magic bullet for years, without success. They’ve tried government-mandated (CAFE) auto mileage standards, tax credits for the use of everything from hybrid cars to low-E windows, massive government subsidies for production of alternative fuels and sincere pep-talks from sweater-clad Presidents. Nothing has worked. Take a look at this chart from the Energy Information Agency:
As it shows, the only break in the steady growth of fossil energy use over the past half-century came with the oil price shocks of the 1970s and 80s. Friedman has discovered a pretty basic rule of economics: If you want people to buy less of something, raise the price.
For another example, take a look at some charts Diane Rogers over at Economistmom.com put together that show what happens, at least in the short run, when gasoline prices change dramatically. We’ve run a nice little natural experiment and the results are fascinating. When gasoline prices exploded last summer, demand plunged. You might say that $4-a-barrel gasoline focused the mind. Then, as prices plummeted over the past few months, consumption again rebounded, even with the economy in the tank.
It is a bit more evidence that consumers of energy will change behavior in response to price. Most economists think it takes a while for people to react, but react they do. CBO figures a sustained price increase of 10 percent will eventually cut consumption by about 4 percent. Others think the long-run response may be even stronger.
Sooner or later, however, if you use a tax to push up the price of energy, people will buy more fuel-efficient cars, appliances, and even homes. They may even think twice about buying that oversized mini-mansion 40 miles from work.
So far, Barack Obama’s transition team has been troublingly mum about raising energy taxes, even though he embraced a tax-like cap and trade program for fossil fuels during the campaign. Aides have dropped broad hints about a new round of big new government subsidies to develop alternative fuels and using a chunk of stimulus money to pay for mass transit. And, of course, Washington has made $25 billion available to automakers for energy R&D and pressed them to make new fuel-efficient cars in return for the additional bailout money they just got.
Giving away money to encourage green behavior is the easy stuff. But it will take more than that. I know, we are in a recession and can’t raise taxes right away. But with gas prices again south of $2.00 a gallon, it is folly to think many consumers will eschew a gasoline-powered $20,000 car for a $40,000 electric ride. Consumers are not dumb, and forcing automakers to build those cars in the absence of demand is madness. So is talking about energy independence without raising the price of fossil fuel.
TaxVox’s Lump of Coal Award: The Ten Worst Ideas of 2008
It was quite a year. Taxpayers are now shareholders in most major U.S. banks, a massive insurance conglomerate, and three failing car companies. After years of debating whether the government was implicitly or explicitly guaranteeing Fannie Mae and Freddie Mac debt, Washington settled the argument by buying the mortgage giants. I know George Bush liked to talk about an ownership society, but I never imagined this is what he had in mind.
And, of course, it was an election year. Thus, the opportunities for dumbness increased exponentially. Campaign promises veered from the improbable to the unworkable to the truly bizarre. With so many bad ideas to choose from, picking the lowlights was not easy. Nonetheless, here is TaxVox’s list of the 10 dumbest fiscal policy ideas of 2008.
10. Barack Obama’s plan to exempt seniors making $50,000 or less from tax. Most already pay nothing. Besides, anybody know why a 65-year-old should get a tax preference over a twenty-something making the same income? Senior discounts should be left to restaurants and movie theaters.
9. Hillary Clinton’s and John McCain’s summer gas tax holiday. Tell me again how we are going to end global warming? Obama gets extra credit for passing on this one.
8. Obama’s windfall profits tax for oil companies. Unfortunately, he couldn’t resist this bad idea.
7. The TARP. A $750 billion blank check. And after giving hundreds of billions to banks, Treasury neglected to make them lend the money to anyone. Polishing their balance sheets may help in the long-run, but hello….
6. Patching, but not fixing, the AMT. It may be a Golden Goody, but this failure of political leadership still smells. We used to worry about the cost of true reform, but that was so 2007.
5. Treasury unilaterally letting banks buy the tax losses of the financial institutions they acquire. The Wells Fargo rule is not only a terrible policy, but Treasury probably had no legal authority to adopt it. Otherwise, a heckuva good idea, as the current president might say.
4. Obama’s proposal to raise Social Security taxes on high-income earners—two years after the end of his second term. A new chapter in Profiles in Courage.
3. The Democrats definition of Middle Class: Obama says anyone making $250,000 or less belongs. Has anyone told him the median income is $61,500? Senator Barbara Mikulski (D-Md), wants to give a tax break to the same folks who borrow up to $49,000 to buy an American-made car. Cadillac owners unite! You have nothing to lose but your On-Star.
2. Extending the Bush Tax Cuts. Did I miss the day Congress etched these on stone tablets? McCain vowed to make them permanent. Obama said he’d repeal many of these breaks, but then assumed they’d last forever—a budget gimmick intended to make his own trillion-dollar promises seem less costly.
1. And the TPC Lump of Coal Award for the single worst idea of 2008: Fred Thompson’s plan to allow people to pick their own tax system. Choice is nice, but this puppy would cut government revenues by $7 trillion over 10 years. McCain and other Republicans all tinkered with this absurd idea, but we’ll give Thompson credit for being the first to raise it in the Presidential campaign. Happy 2009 to all.
More on the New Jobs Tax Credit
Good to see comments on the New Jobs Tax Credit from two authors of papers on the subject, Timothy J. Bartik of the Upjohn Institute and John H. Bishop of Cornell. In response to my criticism of Barack Obama’s call for an employer credit to encourage hiring, both argue that the Carter-era version of this idea—the 1977-78 New Jobs Tax Credit—succeeded in creating as many as 700,000 new jobs in the first year.
Dr. Bartik has written a book on the subject, and Professor Bishop is the author of several scholarly articles on the credit. Both know far more about this than I. However, after reading two of Bishop’s pieces, an essay by Bartik, as well as an article by Jeffrey Perloff and Michael Wachter and Emil Sunley’s tale of the credit’s rather sad history—which TaxVox posted yesterday—I remain far from convinced that this is a good idea.
One problem is the evidence of success Bishop and Bartik cite is very limited. It is based on two surveys, one by the federal government and the other by a business group, which asked whether companies knew about the credit and whether they increased employment. The results: Those aware of the credit hired 3 percent more than those that didn’t. But Perloff and Wachter, who did the initial research on the plan, warned that these results “should be viewed with caution.” Among the difficulties: the sample was not random, and growing companies were the very ones that had the greatest incentive to learn about the credit. Thus, hiring plans may have driven knowledge about the tax break, rather than the other way around.
In addition, the Carter-era plan was very different from what Obama is talking about. Finally, both men acknowledge the old credit was extremely inefficient: About two-thirds of the jobs it subsidized would have been created anyway. Not much bang-for-the-buck.
There are several challenges to designing a workable credit. As I noted in my original post, businesses losing money (those most likely to be cutting jobs) get no immediate benefit unless the credit is made refundable or is used to offset their payroll taxes—either of which create all kinds of other problems. Also, Bishop concedes that in today’s awful economy a relatively paltry $3000 government subsidy won’t encourage many companies to hire. So he suggests a credit of $6550. This would generate more interest, for sure, but it would also more than double the cost and increase the potential windfall to those businesses that would be hiring anyway.
That brings us to the opportunities to game the system. It happens all the time with business credits. The R&D credit, for example, may do more to encourage companies to shuffle internal costs than increase actual research. The problem, of course, is that the more anti-abuse rules, the less attractive the credit becomes to companies that truly could use it.
It still seems that the easiest way to create jobs is the old fashioned method: Boost demand. I’d rather give the money to people who are going to spend it and let their increased consumption drive the job market.
Obama-nomics: Written on a Word Processor
Barack Obama is channeling Ronald Reagan. Not in policy (his proposed tax cuts are not that big) but in tactics. The question is: Can the president-elect convince Congress to spend well over $1 trillion without leaving any fingerprints.
Having learned from Reagan’s legislative successes—notably the Tax Reform Act of 1986—and from Bill Clinton’s failures—see health reform—it appears Obama will never propose any specific economic stimulus legislation. Instead, he is merely sending Congress ideas, and leaving the dirty work of writing a proposal to the Hill. The New York Times Jackie Calmes did a nice post on this the other day.
But not only is Obama’s stimulus what Jackie called the “the paperless plan,” his proposals themselves seem infinitely flexible. For instance, the Obama people let it be known that a key element of the stimulus would be a tax credit to encourage businesses to hire new workers. But when that idea ran into resistance, Obama, as they say, threw it under the bus.
By this morning, Obama aides put out the word that the jobs credit was A) dead or B) about to be significantly retooled. In its place, perhaps, new energy credits. Energy. Employment. Whatever.
It all reminds me of Don Regan, who was Reagan’s Treasury Secretary. The morning Treasury rolled out its detailed version of Tax Reform (known back in the day as Treasury I), Regan was questioned by reporters about some particularly controversial provisions. Not to worry, Regan shrugged, it is all written on a word processor. His clear implication: It was easy enough to rewrite. Btw, for those too young to remember, a word processor was something like a laptop, only it couldn’t get you on the Web.
Obama is coming to Washington with much the same attitude. He’s being even more clever when it comes to the exceedingly unpopular TARP. The incoming president wants Congress to authorize the second $350 billion of this bank bailout money, but instead of asking for the funds himself, he let George Bush do the heavy lifting on his behalf. Poor Bush, I’m sure, would rather be packing.
Don’t get me wrong. I had real doubts about the jobs credit. But the are serious economists who do not. It would have been nice if Congress, say, held a hearing to hear both sides of the argument.
Similarly, there is nothing wrong with a proposal as complex as the stimulus getting tweaked along the way. And, as Reagan showed, a certain amount of flexibility makes for excellent legislative politics.
But sooner or later, Obama, who voted present so often in the Illinois legislature, is going to have to get his hands dirty and take responsibility for unpopular, but necessary initiatives. That, after all, is why they let you stay in the big white house and use the fancy office.
The Bailout and the Next President: Getting Real
Barack Obama and John McCain are slowly beginning to get it: For the next President, this week’s financial market meltdown has changed everything.
Suddenly, their grandiose promises of new tax cuts and ambitious spending are sounding more hollow than ever. An $11.3 trillion national debt will do that to you every time.
Tax Cuts Coming? Investors Don’t Think So
With Barack Obama and John McCain arguing about who is going to cut taxes more, I though it would be interesting to find out what investors think is going to happen to their tax bills in the coming years.
So, in a totally unscientific survey, I asked four money managers what their clients think. The results were striking: Every one said their clients overwhelmingly believed their taxes would rise in the coming four years, no matter who is president. As you watch tonight’s debate, keep in mind both candidates are desparately pitching tax cuts to voters who don’t believe either will deliver.
McCain’s Mortgage Refi Plan: Half a Good Idea
The most interesting thing I heard in last night’s debate between John McCain and Barack Obama (in fact, the only interesting thing I heard) was McCain’s call for a new federal effort to directly refinance residential mortgages into new low-interest loans. The plan got me thinking about a provocative way to pay for it—eliminate the mortgage interest deduction for these new loans.
McCain and Obama Stimulus Plans: The Good, Bad, and Ugly
Both Barack Obama and John McCain have rolled out new economic stimulus plans. Each is a hodgepodge of some good ideas, some not-so-good, and some potentially awful. Obama says his new ideas would cost $60 billion. McCain says his would cost about $52 billion.
Here is a quick look at what they have in mind:
The centerpiece of Obama’s proposal is a new refundable tax credit for companies that add domestic jobs. Businesses would get $3000 for every net new full-time worker they hire. Any business would be eligible, even those that pay no taxes.