How Much Will Obama’s Tax Policies Hurt?

by Patrick Brennan

This week, the U.S. Chamber of Commerce and a few other groups released a study by Ernst & Young examining the effects of allowing some of the “fiscal cliff” policy changes to happen, including allowing the top income-tax rate to rise back to the pre-Bush-tax-cut 39.6 percent, the Obamacare expansion of the Medicare tax, and increases on investment taxes. The findings:

  • Output in the long-run would fall by 1.3%, or $200 billion, in today’s economy.
  • Employment in the long-run would fall by 0.5% or, roughly 710,000 fewer jobs, in today’seconomy.
  • Capital stock and investment in the long-run would fall by 1.4% and 2.4%, respectively.
  • Real after-tax wages would fall by 1.8%, reflecting a decline in workers’ living standards relative to what would have occurred otherwise.

These results suggest real long-run economic consequences for allowing the top two ordinary tax rates and investment tax rates to rise in 2013. This policy path can be expected to reduce long-run output, investment and net worth.

The White House has released what they must consider a forceful rebuttal, entitled “Fact Check: Industry-Financed Study Gets President’s Tax Cuts Wrong” (the nefarious “industry” supporters they don’t trust is any American business that’s part of the Chamber of Commerce and a few other similar associations). They have four objections; first:

The study fallaciously assumes that the tax cuts are used to finance additional spending, ignoring the benefits of what the President actually proposed which was to use the revenue as part of a balanced plan to reduce the deficit and stabilize the debt.

If there’s any “fallacy” here, it’s the assumption that the federal government would ever use tax increases to pay down the debt, reduce deficits, and not finance new spending. Indeed, this is quite clear from the president’s proposals, which continue to increase spending dramatically. And it doesn’t fit with the economic philosophy of this administration, either, which is that the government should provide more stimulus now and investment later, rather than addressing the federal debt. One look at the president’s budget confirms that his administration has absolutely no regard for how debt and deficits hinder economic growth. The trajectory of our entitlement spending is such that tax hikes almost inevitably support “new spending.”#more#

The study also leaves out the President’s proposed new tax cuts for business hiring and investment.

Seeing as the study is specifically an examination of several particular policy changes, there’s nothing remotely misleading about assessing the economic effects of just the increase in the top income rate and ignoring what tax cuts Obama might be proposing. Either some or all might become law, and they’re independent issues. The Obama administration claims that these cuts are larger than the tax hikes he’s proposed — which is only true over the very short run, since the investment credit specifically expires at the end of 2012; and the hiring tax credit, while it doesn’t have a specific sunset, is also a stimulative measure that one at least hopes would be eliminated sooner rather than later.

They also call Obama’s tax munificence “more targeted,” which is technically true but not intrinsically good: Hiring has already been incentivized by a wide range of tax credits (such as the HIRE Act), and we don’t seem to have seen hiring pick up. They’re also “targeted” in other fairly useless, if not distortionary, ways, especially by restricting the credits to small businesses, as if large corporations won’t raise employment, too.

The authors of the new study acknowledge that it has no bearing on the impact of the President’s proposals on the economic recovery and employment in the short-run.   In fact, even they acknowledge that the short-run impact of extending the high-income tax cuts will be proportionately less than the impact of the middle-income cuts.

This isn’t quite accurate: The study is, for one, bears the title Long-run macroeconomic impact of increasing tax rates on high-income taxpayers in 2013,” so the White House has hardly seized on a sly admission, but the study does touch on what the specific tax changes it examines will mean in the short run. They explain, essentially, that we know that the CBO has projected disastrous economic effects of letting the whole fiscal cliff happen; letting the high-income provisions expire is about 10 percent of the entire fiscal impact.

Of course, the White House is also right to assert that the middle- and low-income tax cuts  that Obama (and everyone) will preserve have a much greater budgetary and fiscal impact. That’s because, well, the Bush tax cuts weren’t really tax cuts for the rich. The White House has a pretty flimsy argument: Look, we’re preserving these big tax cuts, which are important, but the medium-sized ones that we’re letting expire, those don’t matter.

Even setting aside the fact that the study ignores the effects of the President’s tax proposals on short-term growth and long-term deficit reduction, the conclusions are still dramatically out-of-line with estimates by other analysts, including not only the Congressional Budget Office but also the Bush Administration Treasury Department.

This is basically their only legitimate criticism: A wide range of conclusions can be reached when making economic projections, depending on what assumptions you begin from. The Chamber of Commerce study, which utilized Ernst & Young’s standard economic model, might well be overrating the effects of these tax hikes via various assumptions, but the CBO and the Bush Treasury department might be underrating the effects. But contra what the White House often seems to think, the flaws of one projection don’t demonstrate that there are no, or low, costs to letting the high-income tax cuts expoire.

All Keynesians know that tax increases, especially $1.1 trillion dollars (over ten years) worth of them, are contractionary, and while we can quibble over the possible effects, Obama can’t deny that letting the top rate rise, then, will hurt the economy. The obvious economic harm of tax increases has been, as Veronique de Rugy has argued in this space, one of the reasons, and maybe the main reason, why many European nations’ fiscal-consolidation “austerity” policies have strangled their economies.

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