Wednesday, September 10, 2008

More on Obama's Tax Plan

After looking more carefully at the details of Obama's proposal, I observe a certain ambiguity in the claim that he is on net cutting taxes, for a reason pointed out by one commenter on my previous post. The plan includes a bunch of "refundable tax credits." It is not at all clear to what extent they ought to be counted as reductions in taxes, and to what extent as increases in expenditure.

Suppose you, like about a third of all tax filers, are currently paying no federal income taxes. You decide to send your child to college, thus qualifying for "A Refundable $4,000 American Opportunity Tax Credit." You are now getting $4000 a year from the government. Labeling it a scholarship or a subsidy, which is what it is, instead of a tax credit, increases both total taxes and total expenditures by $4000. Similarly for the $1000 "making work pay" tax credit, the 10% mortgage interest tax credit, and the health care tax credits.

Current college enrollment is over 10 million full time students, about 5 million part time. If we assume that the credit only applies to full time students, that comes to a total of over forty billion dollars a year. A majority of it will go to reduce taxes paid--more than two-thirds, since higher income people are more likely to send their children to college--and so conventionally goes on the tax side of the calculation, although people have been arguing for a long time that such "tax expenditures" ought to go on the expenditure side. But quite a lot will be money paid to people who were paying no taxes.

This part of Obama's plan is represented as a way of helping people afford college, which it is. But it is also a massive subsidy to low end colleges. The credit only applies to tuition expenses, so if you send your child to a community college that only charges $2000/year, you only get a $2000/year trax credit. But once the proposal is implemented, there won't be any colleges charging $2000/year, or at least very few. Raising tuition to $4000/year increases the income of the college at no cost to the students, so any sensible college now charging less than that will do so. I expect a lot of college professors will be voting Democratic this year, but that is nothing new.

The "Making Work Pay" tax credit, if I correctly read the numbers, costs about another $75 billion dollars. Again, most of that will go to reduce taxes, some of it as payments to people not now paying taxes. The Child Care tax credit looks to come to ten or twenty billion. The Health Care tax credit is not explained in any detail, at least in what I found, so I cannot estimate its size.

If we count all of the refundable tax credits as expenditures, I suspect that Obama's claimed reductions in total taxes and expenditure turn into an increase, although I do not have the data to be sure. I don't know what happens if we count only refunds that are actually paid out, rather than used to reduce the amount the taxpayer pays in.

The general problem, the ambiguity between cutting taxes as a way of subsidizing activies one wants to subsidize and paying out the money directly, is not a new one, so one can hardly blame Obama and his campaign for it. But it is an important one. Transfer payments make up a very large share of the federal budget. With sufficient ingenuity, one could eliminate essentially all of them from the expenditure side by relabelling them refundable tax credits, thus producing, on the books, an enormous reduction in both expenditures and taxes, while actually changing nothing at all. Obama seems to be moving things at least a little farther in that direction.

18 Comments:

At 11:18 AM, September 10, 2008, Anonymous Anonymous said...

Was there something about the Tax Policy Center's analysis or methodology which you found questionable?

 
At 11:29 AM, September 10, 2008, Anonymous Anonymous said...

Transfer payments make up a very large share of the federal budget.

Don't transfer payments make up 100% of the federal budget?

 
At 12:25 PM, September 10, 2008, Blogger Seebach said...

The credit only applies to tuition expenses, so if you send your child to a community college that only charges $2000/year, you only get a $2000/year tax credit.

So it's basically a school voucher for college? I thought the Dems hated vouchers.

 
At 12:42 PM, September 10, 2008, Blogger Alex J. said...

Transferring bombs to the Taliban?

 
At 1:20 PM, September 10, 2008, Anonymous Anonymous said...

"Don't transfer payments make up 100% of the federal budget?"

No, most is spent on buying products or directly employing people.

Increasing transfer payments is, counterintuitively, something that alarms liberals, because it means the government has less money to spend on the things it wants.

 
At 3:23 PM, September 10, 2008, Anonymous Anonymous said...

Clearly I don't know what transfer payments are. Let me see if I understand this correctly.

If you give me $100, and I give that to Bob, that's a transfer payment.

If you give me $100, and I give that to Bob and he gives me a stereo, that's not a transfer payment.

If you give me $100, and I give that to Bob and he gives me a toothpick, that's not a transfer payment.

If you give me $100, order something from Bob, but then decide I don't need/want it, but give Bob $100 as a termination/restocking fee, that's not a transfer payment.

Is that about right?

 
At 6:27 PM, September 10, 2008, Anonymous MachineGhost said...

My impression so far is Obama's tax plan is comprehensively more favorable to taxpayers than McCain's, which counterintuitively seems at odds with the traditional left-right stereotypes. If McCain is more like Bush instead of Reagan, then Obama is more like Clinton instead of Kennedy. It's helpful to remember that when Reagan came into office, the top marginal income tax rate was 90%, so of course everything "trickled down" on the dramatic reductions. The same cannot be said in the current era where corporations pay relatively no income taxes, so reducing the corporate tax rate to 25% from 35% as McCain wants to do makes me wonder what planet he lives on.

One thing you overlooked about the $4K tax credit is that it only is given to those students willing to do 100 hours of community service. So it is an exchange of value, even if its overpriced.

A more important provision is that all seniors making below $50K a year will cease to pay income taxes under Obama's plan. That's a heck of an inducement.

MachineGhost

 
At 7:05 PM, September 10, 2008, Anonymous Anonymous said...

I don't know where you get the idea that corporations pay no taxes? I own a corporation and I pay payroll taxes, social security taxes, sales taxes and an income tax if I am lucky enough to make a profit.

 
At 7:39 PM, September 10, 2008, Anonymous Anonymous said...

"Raising tuition to $4000/year increases the income of the college at no cost to the students, so any sensible college now charging less than that will do so. I expect a lot of college professors will be voting Democratic this year, but that is nothing new."

Is it correct to interpret your statement above as indicative that you subscribe to the self-interested voter hypothesis? It sounds as though you are saying that college professors will perceive this plan as potentially leading to an increase in their wages--but do actually know whether or not most voters favor policies that they judge would benefit them? Of course, I have been somewhat influenced by the arguments put forward in Bryan Caplan's "The Myth of the Rational Voter" on this topic.

 
At 10:58 PM, September 10, 2008, Anonymous js290 said...

I don't know where you get the idea that corporations pay no taxes? I own a corporation and I pay payroll taxes, social security taxes, sales taxes and an income tax if I am lucky enough to make a profit.

Therein lies the cause of the illegal labor market...

 
At 5:11 AM, September 11, 2008, Blogger Russell said...

Corporations pay no taxes. Their customers pay them. They are an expense that cannot be competed away, so any increase gets passsed on to customers.

 
At 6:54 AM, September 11, 2008, Blogger Seth said...

machineghost, I don't know why you claim that the marginal tax rates reached 90% when Reagan took office.

In 1981, the top rate was 69.125%, and the top rate on earned income was 50%.

 
At 7:04 AM, September 11, 2008, Anonymous Anonymous said...

"One thing you overlooked about the $4K tax credit is that it only is given to those students willing to do 100 hours of community service."

Any jail time?

"A more important provision is that all seniors making below $50K a year will cease to pay income taxes under Obama's plan. That's a heck of an inducement."

To not use Roth IRAs?

 
At 10:42 AM, September 12, 2008, Anonymous MachineGhost said...

The GAO says that 80% of U.S. corporations pay no income taxes, if only because they have no profit. But my original statement was made in the vein that tax-paying corporations contribute little as a total percent of revenue collected. The worst publically-exposed example is News Corp which manages to pay only 6.5% or so despite being in multiple countries with top corporates rates nort of 30%, through the use of tax loopholes, accounting gimmicks and tax havens. As a share of revenue, corporate contributions have declined from a high of 22.5% in 1966 to a low of 5% in 1984 up to about 15% in 2006-- obviously from non-ssavvy corporations. This is all aside from the fact that like payroll taxes and FICA, corporate taxes are regressive to the lower and middele class because they're passed on. The question here is whether or not McCain reducing the top corporate income tax rate from 35% to 25% will benefit Americans as much as Obama's personal income tax incentives.

Seth, I didn't mean marginal tax rates reached 90% during Reagan, I implied that they were reduced during Reagan. However, I was confusing Kennedy and Britain with the 90% figure. The actual top personal income tax rate was 70% which was reduced to 28% and corporate from 48% to 34% -- under Reagan.

As for the ROTH IRA, it has only been around for a few years and has pathetic annual contribution limits (that also require you to be a wage-earning employee, to add patronizing insult to injury). Does anyone honestly believe the vast majority of retiring baby boomers who've paid higher effective income tax rates for over 45 years and have annual retirement incomes under $50K have huge ROTH caches? Under $50K is barely lower-middle class.

MachineGhost

 
At 3:21 PM, September 12, 2008, Anonymous Anonymous said...

"Under $50K is barely lower-middle class."

Are you kidding? A $50K income for a retired person (most "seniors" are retired) is upper middle class.

 
At 5:11 PM, September 13, 2008, Anonymous MachineGhost said...

Not joking. From Thompson, William; Joseph Hickey (2005). Society in Focus. Boston, MA: Pearson. 0-205-41365-X:

Lower middle class (32%) Semi-professionals and craftsman with some work autonomy; household incomes commonly range from $35,000 to $75,000. Typically, some college education.

Working class (32%) Clerical, pink and blue collar workers with often low job security; common household incomes range from $16,000 to $30,000. High school education

Lower class (ca. 14% - 20%) Those who occupy poorly-paid positions or rely on government transfers. Some high school education.

Suppose Obama's tax policy meant personal income as opposed to household income. In that case, the tax abatement would be a bigger boonfall for seniors than I originally expressed. Doesn't anyone see the irony of a Democrat offering an income tax abatement for 78%-84% of all seniors?

 
At 7:22 PM, September 13, 2008, Anonymous Anonymous said...

An upper middle class professional does not suddenly become "barely lower middle class" when he retires, just because his income is lower. Don't confuse income with consumption.

 
At 9:36 AM, September 17, 2008, Anonymous Michael said...

Professor Friedman,

How can you speak so favorably about Barack Obama when it is painfully obvious that he abhors capitalism and despises everything your father stood for?

Although this video is couched with the author's opinion, Obama clearly reveals his socialist agenda for America and calls for the end of capitalism in this country. If nothing else, this video is clearly the statement of an egomaniac.

http://www.youtube.com/watch?v=-fxz3UgwCR0&eurl=http://theobamafile.com/ObamaLatest.htm

 

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