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Obama Tax Policy Lacks Boldness, Innovation

Posted on January 21, 2009 by David Cay Johnston
Document originally published in Tax Notes
on January 19, 2009.
‘‘We don’t have Republican or Democratic problems, we have American problems.’’
— Barack Obama

Oh, do we have problems. And one of the biggest is that when it comes to tax policy, our new president is acting with all the boldness of Caspar Milquetoast. The worst economy since the Depression calls for bold initiatives that will solve our economic problems by rebuilding a vibrant economy for all Americans, not just the rich and the superrich.

While the inauguration of Barack Obama as the 44th president this week will be historic in racial terms, on tax policy it looks more and more like all we will get is a softer version of same-old, same-old.

The promise of change that propelled Obama to the White House after just four years as the junior senator from Illinois seems so much more limited in reality than the hope it aroused among the people who elected him. There is nothing bold in his plans, nothing of remaking our tax system for the 21st century.

The president-elect did make one sweeping point, which the news media largely missed, in his first major address since his election. He said our problems are so deep that only government has the means to solve them. With those words — and this is what was missed — he rejected the argument that brought Ronald Reagan to the White House: that government is the problem.

But then he started pandering to the antitax Republicans, part of his fantasy that he can create a postpartisan Washington. Fact: Mitch McConnell, the Senate Republican leader from Kentucky, will never embrace any tax policy that follows the principles laid down by the ancient Athenians and endorsed by Adam Smith and the other classic worldly philosophers. The same goes for the other Senate and House Republicans whose elections were premised on arousing ill-informed hatred of taxes.

So what do we get from Obama instead of boldness? We get a timid financial stimulus package that is unlikely to have enough heft to lift us out of our mess. If it fails and we get into deeper economic trouble, which is a significant risk, the president is less likely to get a second round of major stimulus through Congress. Newly elected presidents, especially those elected with solid majorities, really do have a mandate, but it does not last long.

If the package proves to be too small, if jobs continue to be scarce and house prices keep falling, if stock prices remain low and corporations run into widespread problems coming up with cash to pay interest on their bonds, then we are in for what could be, as Obama himself said, a decade or more of economic woe.

Robert Reich, James K. Galbraith, and I appeared on a panel at the annual economics forum, held by the American Economics Association and the Association for Evolutionary Economics, this month in San Francisco. Reich made an important point: If the stimulus is too small, if too much of it is used inefficiently on business tax cuts, then should the need arise for another injection of government stimulus the votes may not be there, and some cockamamie idea may instead rise up and cause even worse damage.

Yes, Obama plans to retain the estate tax. But despite a huge top-of-the-front-page headline in The Wall Street Journal eight days before the inauguration, that is hardly news. Obama said all along in his campaign that he would keep the estate tax and the exemptions; with those exemptions, the tax applies to only a few thousand of the 2.4 million Americans who die each year. Even the George W. Bush administration never tried to win outright repeal when it had the chance eight years ago, however much its rhetoric sought to create that impression by claiming that all that stood in the way were imagined antiwealth Democrats and Republicans in that multimillionaire’s club known as the U.S. Senate.

And, yes, Obama wants to undo some of the George W. Bush tax shifting by restoring the Clinton top rate on earned income. Just going back to the Clinton rate, however, rates as small beer in terms of change, which is what Obama the candidate promised.

After that, Obama’s tax policy is to continue the tried and failed policies of the last 28 years, including more borrow-and-spend. That should not surprise us because during the campaign the candidate harkened back to the tax policies of the early 1980s, describing them in positive terms and ignoring that they were financed with borrowing that we’re still paying the interest on. The Obama campaign promised in writing to ‘‘cut taxes overall, reducing revenues to below the levels that prevailed under Ronald Reagan (less than 18.2 percent of GDP).’’

He has also bought into the Washington idea of mucking up the tax code with gimmicks. Adding more credits to the tax code will just gum up the works with more complexity and unintended interactions, not unlike the opaque derivatives on Wall Street that created an unsound economy. How about just resetting brackets and rates, including those for the negative income tax we call the earned income tax credit?

Consider the proposed expansion of the child credit. It does nothing for singles without offspring, whose incomes are taxed at a federal marginal rate of 25.2 percent if they make just $10,000. (That’s 10 percent income tax plus both sides of the Social Security and Medicare taxes.)

Back in 1997 the Republicans put forth, and Clinton endorsed, the $1,000 child tax credit for those who paid income taxes, cutting out the poor and those families on the lower rungs of the middle class. The Obama plan is to make this credit partly refundable; however, we will have to wait for the introduction of a bill in the days ahead to see the fine print.

The indication, however, is that parents with tiny earned incomes would become eligible for some of the credit. Tiny here means less than $12,500 to potentially qualify for any of the credit, although as a practical matter the threshold for any significant benefit is thousands of dollars of income higher.

House Democrats want to lower that threshold not to zero, but to $3,000 of earned income. (Hello, it is easy to report $3,000 of phony income on a Schedule C, meaning some of the benefits will be diverted to unethical tax return preparers. This also means more government costs for paperwork and increased disrespect for the tax system.)

Lowering the threshold would have a huge impact on poor children. An estimated 5.5 million children live in households that earn less than $12,000, households that lack enough money for decent food, clothing, and shelter.

At least these plans have two graces. One is that they display decency and a respect for children who did not choose the circumstances of their birth, but whose opportunities in life will shape America for decades to come. That is an investment in both social stability and future economic growth because children raised in severe poverty tend to become tax-eaters instead of taxpayers. The second benefit is that impoverished parents will almost certainly spend the money, and that will help pull us out of our deflationary liquidity trap.

But then there is the plan for business tax cuts — not reform of the business tax system, not reduced rates (a favorite of antitax Republicans). Giving up $100 billion or so of business income tax revenue over the next year or two is unlikely to stimulate the economy much because what businesses need first and foremost right now is customers spending money on their products and services.

Keynesian stimulus spending should be a last resort. Unfortunately, we have had eight years of a president who was more into Keynes than Richard Nixon, who famously declared that we are all Keynesians. The doubling of the federal debt under George W. Bush, before counting his $8 trillion-plus attempt to fight the collapse of artificially inflated assets, has left the nation in a precarious state. In the London exchanges, they are talking openly about the risk that America will default, that even treasuries may not be a risk-free investment. The odds on that are small, but they are not nonexistent,
thanks to decades of borrow-and-spend politics.

When Martin Feldstein, Reagan’s chief economic adviser and a deficit hawk whose sound advice was ignored, says that we must have a stimulus package, that is solid evidence that we must.

The stimulus should aim for the most bang for the least borrowed buck. Raising unemployment benefits by a third or more (many receive less than they would earn from a minimum wage job before deductions) and extending them for six months would get money flowing immediately. It would also be humane. Tripling spending on medical research grants, only about 10 percent of which get funded now, would immediately create jobs. Making grants to states so that they do not lay off police officers, teachers, and other government workers and thus help maintain demand would get results.

Business tax cuts, however, are an ineffective way to stimulate the economy. If they were effective, I would be all for them, but there is abundant economic evidence that they are not the best use of limited dollars. And even in this era of trillion-dollar deficits, dollars really are limited.

Change is what we were promised — real change. Instead it looks like what we may get is just tinkering around the edges: a stimulus package that is freighted with ineffective tax cuts for business and too little spending to overcome the falling prices of assets, a problem that will balloon next year when more than a trillion dollars of toxic Alt-A mortgages reset.

A faint heart never advanced anything. The comic strip character Caspar Milquetoast was part of a once-vibrant industry — newspapers — which failed to embrace the future fast enough and smartly enough and are now dwindling. We need, and we were promised, a president who wanted to take us into the future, but who instead clings to the past, the failed past.

We need change right now in the form of a stimulus that works efficiently from the bottom up by getting people spending. We can then put Keynesian economics back on the shelf until the next time we absolutely have no other choice but to have government prime the pump. We also need a plan to work on fundamental reform of the tax system so that it generates enough revenue to meet demand for government services (or to cut those services the public does not want, like the war in Iraq). We need a system that produces incentives for investment, growth, and, most important of all, a sound
economy for people at all economic levels.

Your thoughts? E-mail me at JohnstonsTake@tax.org.

David Cay Johnston is a former tax reporter for The New York Times . He is also the author of two books about taxes: Free Lunch and Perfectly Legal.