Throughout this election season, we have lamented the misinformation about the candidates' tax plans that has flowed from both sides of the aisle. The Obama campaign has attacked John McCain's health care tax credit proposal, actually a $1.3 trillion net tax cut, as a massive tax increase. Meanwhile, McCain accused Obama of supporting "a tax on electricity" because Obama backs restrictions on carbon emissions—a policy McCain has also endorsed.
This week at National Review's The Corner, we've seen two posts overstating the size of Barack Obama's proposed tax increases. While Obama is proposing significant tax increases on high-income individuals, it is possible to overstate the size of his proposals, and NR bloggers have done so. First, Mark Levin misdescribed the Obama tax plan as a complete repeal of the Bush tax cuts, with some help from American Thinker. (Ramesh Ponnuru quickly responded that this isn't the Obama proposal.)
Today, Victor Davis Hanson vastly overstated the scope of Obama's proposed tax increases on high-income taxpayers. Hanson managed even to outdo RightChange.com, asserting that some taxpayers would see a total income/payroll tax rate of about 65%:
As I recall, the Clintons never introduced legislation repealing the caps on payroll/Social Security taxes. Obama has; and so the new exposure to the 12.4% on self-employed income, coupled with the 2.9% contribution for Medicare, would mean that on self-employed income (and that would be the more likely target), we are talking about a 15.3% tax hike, added onto a 5% additional tax raise on income (34% to 39%).
One can support or reject Obama's plans, but he should at least admit he is not at all going back to the 1990s, but proposing something quite radically new: that anyone in America who makes over $250,000 (the targeted amount seems to change frequently), would pay a new additional tax of 19.3% on their income. And in some states with a 9% state income tax rate, coupled with the 2.9% Medicare rate, one can see that a total tax bite, federal, state, and FICA/Medicare, of at least about 65% of their income, aside from proposed increases in capital gains and inheritance taxes.
This is wrong in several places.
"Anyone in America who makes over $250,000... would pay a new additional tax of 19.3% on their income."
Saying high-income earners would pay a new percentage tax "on their income" conflates total and marginal tax rates. To the extent Obama raises the top two income tax rates or adds a FICA tax for income over $250,000, he increases only marginal tax rates by a stated percentage; a taxpayer's total tax rate (income divided by tax, or tax paid "on their income") would rise by a smaller percentage. The exact percentage depends on the individual taxpayer's circumstances.
Further, the 19.3% increase figure is greatly overstated, even as a measure of marginal tax rates. Hanson arrives at the 19.3% figure by summing three components, two partly false and one totally false. (Note: I recognize the three items below actually sum to 20.3%, however the text of Hanson's post indicates he intends 19.3% as a sum of these three tax increases.)
- A 5% increase in the top marginal rate from "34% to 39%." In fact, the current top marginal rate is 35%, and Obama would let it rise to 39.6%, for an increase of 4.6%. Furthermore, this increase would not apply to "anyone in America who makes over $250,000"; for 2008, the top tax bracket kicked in at $357,700 of federal taxable income for single and married filers. So, this tax increase is smaller than Hanson claims and doesn't apply to all taxpayers earning over $250k. Partly false.
- Application of the 12.4% FICA (Social Security) tax to individual income above $250,000. However, in an August op-ed column in the Wall Street Journal, Obama's economic advisors Jason Furman and Austan Goolsbee wrote that "Sen. Obama does not support uncapping the full payroll tax of 12.4% rate. Instead, he is considering plans that would ask those making over $250,000 to pay in the range of 2% to 4% more in total (combined employer and employee). This change to Social Security would start a decade or more from now." So, Obama's proposed increase would likely be much smaller than Hanson says and wouldn't start until at least 2018. Also partly false.
- Application of the 2.9% Medicare tax to all income. While this tax would be applied under the Obama plan, it is also current law (and, indeed, would also be applied under the McCain plan, just as President Bush has applied it.) Thus, it is not a tax increase at all. Totally false.
Instead of 19.3%, the correct figure would be something in the ballpark of 6.1% (4.6% increase in the top income tax rate, plus a 1.5% increase in the top marginal rate for many high-income taxpayers due to rules phasing out deductions and exemptions), or 10.1% after 2018 if Obama levies a 4% FICA tax on incomes over $250,000. And again, that marginal tax rate increase wouldn't apply to all taxpayers with incomes over $250,000, because some would not be in the top tax bracket.
Later on, Hanson says:
"And in some states with a 9% state income tax rate, coupled with the 2.9% Medicare rate, one can see that a total tax bite, federal, state, and FICA/Medicare, of at least about 65% of their income." (Emphasis added.)
Here, Hanson again conflates marginal and total tax rates. Even if Hanson were correct that the Obama plan would expose some taxpayers to a 65% marginal tax rate (and that claim, based on the assumptions above, is false) it would not expose them to "total tax bite" of 65% of their income.
More broadly, Hanson contests Obama's frequent theme that he would merely return high income taxpayers to the rates they paid during the 1990s under Bill Clinton. It is true that, if enacted in 2018, the new 2-4% FICA tax on incomes over $250,000 would represent an increase over the Clinton era.
However, the return to a 39.6% top income tax rate and a 20% capital gains rate for high earners would both represent returns to pre-Bush tax cut law. And high earners, under Obama, would still pay a lower-than-Clinton rate on the part of their income that is taxed under the first four income tax brackets (that is, the first $208,850 in taxable income for most married filers as of 2008.)
Since those tax benefits do not apply at the margin, they are essentially a lump-sum savings to taxpayers and do not encourage economic output in the way that top marginal tax rate cuts would. Essentially, Obama would keep some tax benefits for high-income individuals but junk the ones that are most conducive of economic growth. That's a shame, but it's still not a 19.3% tax increase on anybody.
So today's Los Angeles Times had a story about how Obama and McCain differ on taxes with the theme that Obama focuses on questions of vertical equity and McCain focuses on efficiency. In the article, there was a quote from Jared Bernstein of EPI:
"You can't find evidence that low tax rates foster high economic growth," said Jared Bernstein, director of a research program at the liberal Economic Policy Institute. "In my view, Medicare, education, child care and preschool services that the government provides are going to be more necessary in the future."
I'm not sure what Bernstein's definition of "high economic growth" would be, but if he's implying that there is no evidence that lower tax rates help promote economic growth, he's way off the mark. Of course, it's not always the case that a tax rate cut is going to promote economic growth given that there must be some spending offset, but I could come up with a pretty good list of tax rate cuts financed by spending cuts that would increase economic growth.
It is true that better education pre-K through grade 12 would promote economic growth, maybe even more than tax rate cut. But I can guarantee that if you cut farm subsidies out of the budget and lowered tax rates accordingly, economic growth would be fostered. (As for Medicare promoting economic growth, I'd say that's a stretch...maybe universal coverage for those under 25, but not for those 65+.)
Ask any left-of-center economist who opposed the Iraq war whether or not economic growth would have been higher under lower taxes instead of spending that money in Iraq. They would be unanimous in telling you that lower taxes would have been preferential (holding the deficit constant).
If Bernstein's standard for "high" economic growth is that a tax cut pay for itself, I would agree that no major tax rate cut at today's tax levels is going to promote that much of economic growth. (I'm referring to major federal taxes, as I'm sure there is somewhere out there in a state that lower tax rates would pay for itself...say on a cigarette tax or something where there is huge border activity. Also if you consider certain prohibitions to be implicit taxes, repealing them and in effect cutting tax rates would pay for themselves.)
But Bernstein's position seems to be like many on the left, which is a lexicographic preference for government always getting bigger, and he's trying to act as if it's a free lunch. It's very similar to the view of those on the right who say that government is a waste and should be starved of all revenue. The fact of the matter is that the optimal size of government > 0, but it's optimal size is not 100 percent of the economy (and there would be substantially lower economic growth if that was the case).
There are some government spending items currently in existence that are not worth their costs to taxpayers. Then again, there are some hypothetical government spending items that do not exists right now that would be worth additional tax dollars. The secret is finding which spending items are worth their costs and only funding those, and raising the necessary revenue in the best possible way that meets various criteria (such as equity and efficiency).
It is one of the paradoxes for those who seek to rally support for starving the beast (even if it worked say at the state level under a balanced budget rule). You are starving a beast because you view the beast as too wasteful and not looking out for the best interest of the taxpayer. But whose to say that when you starve it, it's going to devote its now more limited resources to the best interest of the taxpayers. It may starve you in return of the services you and those who you seek to garner support from value most (since you already believe that it doesn't look out for your own interests), thereby not getting rid of the programs at the margin that aren't worth their costs to taxpayers but instead getting rid of the programs that are worth their costs.
Voters in 23 states will be considering initiatives and referenda relating to tax issues on November 4. Our new report, Tax Foundation Fiscal Fact No. 154: Voters Will Consider Tax-Related Ballot Initiatives in 23 States, summarizes each of them and the arguments made by proponents and opponents.
For the full list, check out the report. Here are some of the more prominent initiatives:
Arkansas - Proposed Constitutional Amendment 3 would establish a state lottery, with the proceeds used for college attendance scholarships. Arkansas is one of eight states that do not have a lottery; a similar measure failed in 2006. Proponents including Lt. Gov. Bill Halter point to programs the lottery revenues would fund. Opponents argue that lotteries are a regressive form of taxation and are accompanied by social costs. This Tax Foundation commentary discusses Measure 3.
Colorado - Amendment 59. In 1992, Colorado voters approved a Taxpayers Bill of Rights (TABOR), which capped state spending according to a formula of population growth plus inflation, unless a referendum approved exceeding the cap. The surpluses which resulted in subsequent years were used for education, saved in a rainy day fund, or refunded to taxpayers. Because TABOR's formula was based only on the previous year's spending, a one-time drop in revenue (during a recession, for instance) would "ratchet" down the cap for subsequent years. This provision was modified in 2005, when voters changed the formula to the highest collection in the last five years and suspended rebates through 2010 (diverting the money to education). Additionally, Amendment 23 requires annual increases in education funding, which with TABOR creates budget pressure. Amendment 59 attempts to address this problem by making permanent the elimination of rebates (with the money going instead to education), and exempt education spending from TABOR's caps. Proponents support the increased education funding and argue that the constitutional reform is needed. Opponents say Amendment 59 effectively repeals TABOR's limits, and that Amendment 23's problems can be addressed in better ways.
Maryland - Question 2 would authorize the state to provide video lottery terminals (slot machines) in five locations in the state, with the $600 million raised funneled into education programs. Maryland recently raised taxes but the revenue increase is lower than projected, and along with spending increases has created a new budget shortfall. Proponents such as Governor O'Malley argue that slots can increase revenues without raising other taxes, and that some of the revenue can be pulled from neighboring states. It could also be said that by permitting some gambling, the state would give consumers more choice than they do at present. Opponents argue that state-sanctioned gambling is just a type of taxation and is associated with social costs, and that the measure does not address spending.
Massachusetts - Question 1 would cut the state income tax in half for 2009 and repeal it completely beginning in 2010. The state income tax currently tops out at 5.3 percent, and brings in $12 billion in revenue (out of a $28 billion state budget, not including "off-budget" expenditures and local government spending). If the initiative passes, Massachusetts would become the tenth U.S. state with no state income tax, joining Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming. (But New Hampshire and Tennessee tax some individual investment income.) Proponents point to wasteful spending on projects like the Big Dig and toll roads and recent increases in spending. Opponents such as Governor Deval Patrick earlier this year called the proposal "irresponsible," saying it would contribute to "broken roads..., overcrowded schools... [and] broken neighborhoods." A similar measure received 45% of the vote in 2000.
North Dakota - Measure 2 would lower the state's corporate income tax by 15 percent and the state's personal income tax by 50 percent. This Tax Foundation paper extensively discusses Measure 2.
Oregon - Measure 59. Currently, Oregon taxpayers can deduct their federal income taxes from their state income taxes up to $5,600. Measure 59 would remove this cap beginning in 2010, reducing state revenues by $1.3 billion in the next two-year budget. Proponents say the measure repeals a double tax on income, while opponents argue that the revenue reductions would harm state programs.
Check out the full list here.
California Governor Arnold Schwarzenegger (R) yesterday signed an executive order establishing a 12-member panel to review the state's tax code. Schwarzenegger specifically cited the swings in tax revenue caused by heavy reliance on capital gains income:
General Fund revenue over the last several decades has fluctuated dramatically due to changes in the economy in general, but primarily as a result of the volatility that is inherent in California's current tax system[....]
[T]his fluctuation in General Fund revenues creates difficulty in funding the operations of government year-to-year, as the need for state services such as operating state parks, operating state prisons, overseeing elections and providing funding for healthcare and social services do not change in response to revenue, but in relation to population, demographics and service availability[....]
The panel will be comprised of 6 members including the chair appointed by the Governor, three by the Assembly Speaker, and three by the Senate President Pro Tem. The commission must provide its report on or before April 15, 2009.
It's Halloween, and taxes will probably be the last thing on the minds of the young ghosts, ballerinas, witches, and superheroes who go door to door collecting candy tonight.
But the grown-ups who buy the candy might want to give taxes a bit of thought, especially if they live in a state that has ridiculously complex laws regarding the taxation of candy. At Easter time we lamented the trouble the Easter Bunny has calculating his tax burden when he purchases candy and other supplies for Easter baskets. We picked on Iowa as an example of a state where the Easter Bunny would have an especially difficult time determining the amount of tax he'd have to pay at the checkout counter.
Iowa has adopted the Streamlined Sales Tax Project (SSTP) and has some confusing rules about taxes on certain types of candy (taxes on other types of food can be just as confusing, as this issue paper on the SSTP's taxation of food shows). When the SSTP when into effect in Iowa, food containing flour was not considered candy anymore, even if most rational people would argue otherwise. For example, classic Milky Way bars, which contain flour, are not considered candy and are therefore tax-exempt, while Milky Way Midnight (dark chocolate) bars are taxed because they do not contain flour. This obviously creates technical difficulties for retailers and confusion for consumers.
From the Rhode Island Division of Taxation:
The exemption for food under R.I.G.L. 44-18-30(a) does not apply to "candy." "Candy" is defined as any "preparation of sugar, honey, or other natural or artificial sweeteners in combination with chocolate, fruits, nuts, or other ingredients or flavorings in the forms of bars, drops, or pieces." The term "candy" does not include any preparation containing flour as an ingredient.
Because many products commonly categorized as candy contain flour, packaging labels must be examined to determine which items are deemed taxable candy or exempt food products. Examples of items exempt after January 1, 2007 include KitKats, Twix, some licorice, Nestle Crunch, and Milky Way.
"Some licorice"? This means that anyone purchasing last-minute Halloween candy today may want to check the label of licorice packages carefully since some brands contain flour while others do not. Does it really make sense to tax licorice that does not contain flour, and exempt licorice that does, or to make any decision about taxes based on such a picayune criterion?
Levying a different tax rate on candy or any type of "junk food" than on other food creates enough confusion for consumers as it is, without the additional minute distinctions between various types of "junk food." Most shoppers probably are not even aware of the different tax rates for different types of food, which is problematic, since sound tax policy requires simple, transparent taxes that are easy to comply with. Shoppers should not have to scrutinize the labels of every item on the shelf to determine what is taxed and what is not, nor should they have to take a copy of the state's tax laws to the grocery store along with their shopping lists.
The taxes on that candy everyone is handing out tonight might just end up being the scariest part of Halloween.
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