Wednesday, August 13, 2008

Obama's Damaging Tax Plan

Greg Mankiw on his blog showed a chart (see below) on how marginal tax rates at different tax levels will be affected by Barack Obama's tax plan. This just covers low- and middle income workers, the tax rates will be raised for high income earners as well.

"Economists for Obama" (via Economist's view) reacted negatively on this, accusing Mankiw and those who originally produced the chart (Alex Brill and Alan Viard) of being dishonest. The reason is that these increases in marginal tax rates will not occur because of increased tax payments from the middle class, but from reduced tax payments. But how could marginal tax rates increase as a result of a plan that will reduce tax payments? Simply because Obama advocates higher tax credits, tax credits which will be phased out at higher incomes.

Actually though, at least Brill and Viard (Mankiw's chart too is open about referring to marginal tax rates) are very clear that they are referring to marginal tax rates and not total tax payments. And while the introduction tax credits which are phased out is definitely likely to be more popular than outright tax rate increases which raise tax bills, such tax credits are in fact likely to be even more damaging to the economy. The reason for this is that this will not only create a negative substitution effect which reduces labor supply, this effect will be reinforced by the income effect from lower tax bills. Furthermore, the increase in the budget deficit that this creates will have a crowding out effect on private investments.

While tax increases meant to reduce the budget deficit have a theoretically ambiguous effect on growth (the substitution effect will reduce it, the income and crowding out effect will increase it), Obama's plan of phased out tax credits has a ambiguous negative effect as the substitution effect not only is not counteracted by the income and crowding out effects, it is in fact reinforced by them.

This kind of economic irrationality is also mirrored by Obama's plan to raise taxes on oil companies and use the revenues for additional so-called tax rebates for the middle class. Hmmm...increased taxation of oil production combined with consumption stimulus, implying lower supply and higher demand, what kind of effect can that have on the oil price?

The American economy already faces great problems because of the destructive policies of Greenspan and Bernanke. Tax plans of this kind will only make these problems worse.


Blogger Wille said...

Why are politicians so hooked on tax credits? "We'll take your money, and if you know the ins and outs of the system and rules, we might give a little back".

In the UK, the tax credit system for low income earners has been fraught with fraud counting in the billions of pounds, while at the same time a lot of people they where directed at have ended up without any, due to not knowing how the system works.

10:44 AM  

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