Tuesday, October 21, 2008

WSJ: Obama Talks Nonsense on Tax Cuts

Columnist Bill McGurn writes for the Wall Street Journal:

Now we know: 95% of Americans will get a "tax cut" under Barack Obama after all. Those on the receiving end of a check will include the estimated 44% of Americans who will owe no federal income taxes under his plan.

In most parts of America, getting money back on taxes you haven't paid sounds a lot like welfare. Ah, say the Obama people, you forget: Even those who pay no income taxes pay payroll taxes for Social Security. Under the Obama plan, they say, these Americans would get an income tax credit up to $500 based on what they are paying into Social Security.

Just two little questions: If people are going to get a tax refund based on what they pay into Social Security, then we're not really talking about income tax relief, are we? And if what we're really talking about is payroll tax relief, doesn't that mean billions of dollars in lost revenue for a Social Security trust fund that is already badly underfinanced?

Austan Goolsbee, the University of Chicago economic professor who serves as one of Sen. Obama's top advisers, discussed these issues during a recent appearance on Fox News. There he stated that the answer to the first question is that these Americans are getting an income tax rebate. And the answer to the second is that the money would not actually come out of Social Security.

"You can't just cut the payroll tax because that's what funds Social Security," Mr. Goolsbee told Fox's Shepard Smith. "So if you tried to do that, you would undermine the Social Security Trust Fund."

Now, if you have been following this so far, you have learned that people who pay no income tax will get an income tax refund. You have also learned that this check will represent relief for the payroll taxes these people do pay. And you have been assured that this rebate check won't actually come out of payroll taxes, lest we harm Social Security.

You have to admire the audacity. With one touch of the Obama magic, what otherwise would be described as taking money from Peter to pay Paul is now transformed into Paul's tax relief. Where a tax cut for payroll taxes paid will not in fact come from payroll taxes. And where all these plans come together under the rhetorical umbrella of "Making Work Pay."

Not everyone is persuaded. Andrew Biggs is a scholar at the American Enterprise Institute and a former Social Security Administration official who has written a great deal about Mr. Obama's plans on his blog (AndrewGBiggs.blogspot.com). He notes that to understand the unintended consequences, it helps to remember that while people at the bottom pay a higher percentage of their income in payroll taxes, they are accruing benefits in excess of what they pay in.

"It's interesting that Mr. Obama calls his plan 'Making Work Pay,'" says Mr. Biggs, "because the incentives are just the opposite. By expanding benefits for people whose benefits exceed their taxes, you're increasing their disincentive for work. And you're doing the same at the top of the income scale, where you are raising their taxes so you can distribute the revenue to others."

Even more interesting is what Mr. Obama's "tax cuts" do to Social Security financing. As Mr. Biggs notes, had Mr. Obama proposed to pay for payroll tax relief out of, well, payroll taxes, his plan would never have a chance in Congress. Most members would look at a plan that defunded a trust fund that seniors are counting on for their retirement as political suicide.

And that leads us to the heart of this problem. If the government is going to give tax cuts to 44% of American based on their Social Security taxes -- without actually refunding to them the money they are paying into Social Security -- Mr. Obama will have to get the funds elsewhere. And this is where "general revenues" turns out to be a more agreeable way of saying "Other People's Money."

When asked about his priorities during the second presidential debate, Mr. Obama said that reform of programs like Social Security would have to go on the back burner for two years or so. "We're not going to solve Social Security and Medicare unless we understand the rest of our tax policies," he said.

The senator is right. But you have to read the fine print of his tax cuts to know why.


llh said...

They've got the wrong url to your blog on WSJ. They leave out the G in the middle and some guy in Thailand is getting your referrrals.

Andrew G. Biggs said...

Thanks very much -- my research assistant has contacted the Journal about the typo. Best,


bubbleRefuge said...

Mr Biggs, I've concluded from reading economist Warren Mosler's blog that the wall street journal and the rest of the financial press as well as both political parties are analyzing tax policy and macro-economic policy in an obsolete economic model. They appear to be espousing economic fundamentals that apply to a fixed exchange rate/gold standard regime. Currently, we are in a soft-currency floating exchange rate regime. Among the principle implications of this innocent fraud is the fact that government is funded via taxation which it is not. In a soft currency regime, taxation gives value to the currency and controls the level of aggregate demand. Right now, according to warren, we need a payroll tax holiday in order to stimulate demand and return to growth. See www.moslereconomics.com for white papers and discussions.
Sir, how can so many people be so wrong about the economic fundamentals?

shoffy22 said...

Very interesting to read the WSJ article and your post on Obama's tax proposal. Thanks for the good discussion of a lot of the plan's details.

I'm surprised at the opposition to using the income tax system and general revnues as a means to provide income support and payroll tax relief to people. I think the redundable EITC was first justified as a way of providing tax relief from the payroll taxes that low income workers with children were paying. It seems like Obama's plan is a large expansion of the effort first started with the EITC?

I agree with your point that there might be smarter ways to allocate the 710 billion 10 year price tag that this program would cost. One idea for how this plan could be tweaked so that this money is better targeted toward helping people with future retirement security that I think would be cool is this -

First set up a universal Add-on PRA system that every worker in America can participate in. Then give every worker double credit for the first $500 they pay in payroll taxes, so that the 6.2% up to $8000 in income that employees pay gets counted both for traditional social security and then also gets put into their new PRA account.

Doing this could ensure that every worker saves at least $500 each year for their own retirement account, even in years where they are unable to save on their own. The $500 credit would be paid by general revenues and could be justified as a targeted investment to supplement the social security system and traditional benefits.

Andrew G. Biggs said...


A good comment as always. I guess here's how I'd think about it: Social Security was set up by Roosevelt with a certain kind of structure -- as an "earned benefit" rather than as a "welfare program." That was deliberate, and is reflected in the tax/benefit linkage and the fact that we don't fund the program with income tax revenues.

Now, I can imagine a different pension program that didn't have a tax/benefit linkage and did use general revenues -- for instance, New Zealand's universal pension (paid out of GRs to everyone in the country, regardless of past income) works that way, and I think there's a case to be made for it.

But that final clause is the point: you actually have to make the case for a different kind of Social Security program and argue why we should make the change. Obama's plan essentially would shift away from an earned benefit funded by payroll taxes toward a needs-based benefit funded with income taxes, but he doesn't explain what he's doing or why. That's my real issue. While your ideas are interesting and definitely have some merit, the key question is why we want to change how we've been doing things.

bubbleRefuge said...

There is no funding issue related to federal spending of any sort. Federal government spends first and taxes later to maintain demand for the currency. We don't need social security and medicare taxes to fund those programs (which by the way are regressive taxes). National debt exists is a tool to hit federal funds rate targets not to fund government. There is a huge misunderstanding about reserve accounting.

Truth Wanted said...

Mr Biggs and Mr Bubblerefuge,

I am just an average citizen but I have an interest in the issues you are discussing and perhaps each of you can help me understand better. It seems to me the problem is even much larger than the current crisis we face. EITC's, payroll tax holidays, PRA's which I assume to be Private retirement accounts seem to me as a way to get by until we are ready to face up to our big big problem which everyone is afraid to address.

It is my understanding that the National debt with the recent bailout is near 10 trillion dollars. The government continues to spend more each year than it takes from the American people in taxes. The National debt continues to grow and interest must be paid on this debt. My guess is the deeper in debt and the ability to pay that debt may determine the interest rates at which one can borrow. Higher rates, if they occur present another problem.

It is also my understanding that the baby boomer generation has entered retirement age and also the age where health becomes a major factor as one ages. Will there not begin a tremendous surge in Social Security benefits paid out and Medicare health cost begin to rise at a rate faster than any previous time in history? This trend should continue for the next 20-40 years until all the baby boomers reach retirement collect benefits and pass away.

With our continued penchant for deficit spending and the growing burden of social security and medicare our National debt could approach 60-80 trillion dollars or more in that time. the interest on such debt would seem to devour a substantial portion of our GDP.

Raising taxes would seem to rob incentive to put new capital into our economy. The potential return on investment seems to be the incentive for those with capital to put it at risk. Just like a casino the house always wins. So there will be winners and losers but the more people playing the game the more the house ( the economy ) takes in. Reduce or tax the payout and less people will play and less money will be taken in.

There seems to be a very fine line between the rate to tax before players take their winnings out of the market and wait for the "table" to get hot again.

Right now the present world economic conditions are showing a very "cold table" The only way to bring people back in to the game is not by increasing taxes or giving the "losers" some of the "winners" dollars, but keeping taxes low and perhaps even reducing capital gains to bring the risk takers back to betting on the US economy. BUT in addition it seems we must keep spending under control to keep the "house" solvent so the winnings can be paid to those willing to take the risk. The jobs created and the taxes paid to the government from those jobs when the "table" gets hot again will more than make up the higher payout in capital gains paid to those who bet that the economy will grow.

This makes sense to me versus trying to grow our economy from the bottom up by giving tax breaks to the upper middle class and tax credits to the lower middle class by transfering the capital of the upper class out of the economy and in to the hands of people who will spend it in two months and give only a temporary boost to the economy.

As I mentioned I am an average citizen, a musician and a record producer, with no college education. My wife and I happen to do very well while living in California. we ended up in a tax bracket of 39% Federal and 11% State taxes while we lived there BUT we lived very modestly and ALWAYS spent much less than we earned for 20 years. When we had saved enough we retired early and moved to Tennessee where there is no income tax. Kinda like big companies moving out of the country because it is cheaper to do business. Aaaaah, but that is another discussion.

Mr Biggs and Mr Bubblerefuge, I would genuinely appreciate more of your insight into these issues. I plan to follow your blogs and look for new and interesting views and potential solutions to the problems facing us today. I would be open to more sources of where I might find these kinds of discussions and information.