Gallup asks a stupid question

If they asked me, how the hell would I know what they mean by "spending cuts" and "tax increases"? They don't specify the baseline (status quo). Is letting the Bush tax cuts expire a "tax increase"? Is not doing another "doc fix" (or doing a partial one) a "spending cut"? Asking such a vague question almost guarantees that everyone who understands it will refuse to answer, and hence only those who don't know what they are talking about will participate in the survey. Maybe that explains the scary answers given.

A lot more people say they prefer spending cuts than tax increases. That's crazy by any interpretation, but it is even worse if people tend to understand those terms the way I think they do, which is that anything that causes taxes to go up from where they are today is a tax increase (i.e., it doesn't matter that the Bush tax cuts are scheduled to expire; when they go up, it's a tax increase). In that case, even equal shares of tax increases and spending cuts would require radically shrinking the government.

And only 11% of respondents prefer mostly or exclusively tax increases. Heck, only 20% of Democrats prefer mostly or exclusively tax increases. We have found the enemy, and it is us.

Mankiw bequeaths $7M to middle-aged kids for down payment on first home

I have several economists' blogs on my blogroll. I have a couple of conservative economists' blogs on my blogroll. Greg Mankiw's blog is not one of them, and for a good reason. Although Mankiw is undeniably a first-class economist in terms of his contributions to academic research, his public-policy positions could be charitably described as naive and simplistic, and most of the stuff he writes in his blog is just crap. (His position on Pigouvian fuel taxes may be a notable exception, but I take it more as a confirmation the issue is so non-controversial among economists that even right-wingers agree with the normal people.)

Did I say crap? Mankiw's recent post on his work incentives under McCain's and Obama's tax proposals makes crap look appetizing in comparison. He computes:

even under the low-tax McCain plan, my incentive to work is cut by 83 percent compared to the situation without taxes. (...) Obama's proposed tax hikes reduce my incentive to work by 62 percent compared to the McCain plan and by 93 percent compared to the no-tax scenario. In a sense, putting the various pieces of the tax system together, I would be facing a marginal tax rate of 93 percent.

and concludes:

The bottom line: If you are one of those people out there trying to induce me to do some work for you, there is a good chance I will turn you down. And the likelihood will go up after President Obama puts his tax plan in place.

Jonah the Economist does some pretty good debunking of Mankiw's fallacies, showing that Mankiw uses wrong formulas and wrong parameters, as well as a misleading source for his numbers. But the problems with Mankiw's post don't end there; his underlying logic is fatally flawed. Even if the numbers were correct (they are not), his argument would not hold water.

Mankiw's main premise is that any extra dollar he might earn would be set aside, invested, and bequeathed to his children. That is the only way he gets to apply all taxes to it. And here is how he describes the goals he has for those bequests:

To a large extent, the beneficiaries of that extra effort are my kids. My lifestyle is, as a first approximation, invariant to my income. But if I make an extra few dollars today, I will leave more to my kids when I move on. I won't leave them enough so they can lead lives of leisure, but perhaps I will leave them enough so they won't have to struggle too much to afford a downpayment on their houses or to send their own kids to college.

However, to apply a 45% estate tax under Obama's plan, he must be assuming that the amount of his bequest will exceed $7 million (in today's dollars). His stated modest goals are totally inconsistent with bequeathing that amount. Moreover, as an economist, Mankiw ought to realize that inheriting millions would greatly reduce his children's incentives to work.

Mankiw's narrative is not convincing to any reader seeking more than to validate his own prejudice that Obama will raise taxes and destroy the economy. It is unlikely that, as a star professor who obviously loves what he does, he works primarily for money. Even if he does, he states explicitly that he doesn't want any more money for himself, but only for his children. I like how he describes the purpose of the bequests, but it doesn't add up chronologically. I don't know how old Mankiw's children are, but he is 50, and his calculations assume that he will live to 85. By then, I would think his children would be at least in their 40s. If one of the most successful economists in America believes that his children will need help with down payment on their first homes when they are almost his present age, he is either extremely pessimistic or full of shit.

The very end of Mankiw's post is perhaps its best part:

And the likelihood will go up after President Obama puts his tax plan in place. I expect to spend more time playing with my kids. They will be poorer when they grow up, but perhaps they will have a few more happy memories.

Whether he arrived at this conclusion by flawed logic or not, the outcome seems the best for all parties involved (especially if "poorer" means having only $7,000,000.00 instead of $7,000,001.85). He is actually implying that he and his kids will be better off under Obama's plan (and we will too, as Jonah the Economist concludes). Could anybody refute Mankiw's main point more effectively than Mankiw himself?

I picked the wrong week to quit cutting taxes

The world has changed a lot in the last month, so let me back off my appeal to the candidates to break their tax-cutting promises. This is not the time to think about long-term fiscal responsibility. That must wait until we are out of the recession.

However, I hope there will be many years of Obama presidency after we are out of the recession, and I hope Obama will have the wisdom to break his promise then, and the charisma to convince the American people not to hate him for that broken promise.

Do we really need lower taxes?

It may be impossible to get elected in the US these days without promising tax cuts. Obama, the more fiscally responsible (or, more accurately, less irresponsible) of the two major-party presidential candidates, has promised not to increase the taxes of anyone earning less than $250,000 a year. I understand that low- and average-income people are hurting, but are families with incomes in the low 6-digits really that burdened with taxes that they can't pay more?

The usual response to this question is that higher taxes, and higher marginal taxes in particular - that is, higher rate of tax on the next dollar earned - reduce incentives to work and save, and thus reduce output and capital formation and slow down economic growth. Neoclassical economic models "prove" that low taxes are good for the economy (as long as government spending is also low, a detail often ignored by the passionate tax-cutters). But historical evidence hardly supports that theory.

People with good incomes faced higher marginal tax rates in the 1950s and 1960s, yet the economy was strong and growing fast, people worked just as hard as today, and saved more. As an example of a well-to-do, but not rich, families, I chose those whose income equaled the Congressional salary in each year. The blue line in the graph below shows the marginal tax rate (popularly known as the "tax bracket") that such a family, with two children and no itemized deductions, faced from 1955 to 2008.


Additionally, the orange line shows the tax bracket of a family earning twice the Congressional salary - a family just wealthy enough that its taxes would increase under Obama's plan. From a historical perspective, those people have paid ridiculously low taxes in the last two decades. And we are not even talking about multi-million-earning CEOs, who might have been in the 90% bracket during the Eisenhower administration.

So why would anyone think that a big tax hike on the well-to-do would kill the economy?

Obama: "Read my lips!"

I don't like this pledge not to raise taxes. You can't restore fiscal balance by taxing only the rich, and then not even them too much. Are Americans really that stupid and immature that they won't vote for anyone who doesn't promise to burden their children with huge debt cut their taxes?

Yes, Obama's plan is a lot better than McCains. Trillions better. The choice between the two is clear. But it is sad that we are not even offered the choice of a fiscally responsible plan. It's like a small car in the 1990s - there just isn't a market for that product in America. It took $4 gas for Americans to discover small cars; what amount of national debt will it take to discover fiscal discipline?

According to Tax Policy Center, Obama's plan would increase revenues by $600 billion over the next 10 years relative to "current policy", while McCain's plan would reduce revenues by a similar amount. Here, "current policy" means extending the Bush tax cuts; if we compare to current law, in which those tax cuts expire in 2011, we are talking about revenue losses of $2.9 trillion (Obama) or $4.2 trillion (McCain). And that's not even counting their health care proposals, which are harder to compare side-by-side (McCain's would lose another $1.3 trillion in revenues; Obama's would mostly affect the spending side).

My message to whoever gets elected: please, please break your tax promises!

Not every McCain idea is bad

With the McCain campaign banging pots and the media amplifying the noise, we haven't been able to hear much about the issues in the last few days. Maybe that's why Joe Klein reached for the old news and commented on McCain's plan to change the tax status of employer-paid health insurance premiums. His analysis is balanced, but in the punchline he focuses on the tax-increase aspect of it:

It is amazing to me that Obama campaign has let things go this far without pointing out that McCain--who opposes the energy bill because it would increase taxes on oil companies--is actually proposing a tax increase on health care benefits for American workers. But that is precisely what the Senator from Arizona is doing.

Ezra Klein goes further:

This is a tremendous tax increase, to the tune of $3.6 trillion over 10 years.

Although he goes on to qualify that statement, it is not a fair critique by any stretch of imagination.

I don't like McCain's vision for health care and his non-reform "reform". I think he wants to take it in the wrong direction and will only make the problems worse. But this tax proposal is actually not bad at all. It would remove a major tax distortion and most people would be better-off (well, sort of - as taxpayers, they'd have to pay it back eventually).

Currently, employer-paid health insurance premiums are not counted as taxable income to employees, but are fully deductible as expense to the employer. In effect, the government subsidizes the premiums at the employees' marginal income tax rates. And because income tax rates increase with income, high earners get a bigger subsidy than low earners.

This is unfair to low earners - it reduces the progressivity of the tax code in a non-transparent way. But it also distorts the health insurance and labor markets, because people who pay for their own insurance get no subsidy. That makes the current system unfair to the self-employed and to workers whose employers don't offer a health benefit. It also discourages entrepreneurship by making self-employment more expensive.

McCain's plan would treat employer-paid health insurance premiums as cash income for tax purposes, but would offset the added tax cost with a refundable tax credit of $2,500 per year to individuals and $5,000 to families. "Refundable" means you get the full amount even if your total federal income tax for the year is less than that - the government writes a check to everybody who has health insurance. If you have family coverage and your employer pays $8,824 per year for it (the national average), counting it as income will increase your tax from $882 (if you are in the 10% bracket) to $3,088 (if you are in the top, 35%, bracket), but with the refund, your tax will decrease by $1,912 to $4,118. (If Social Security taxes also apply, the numbers are less favorable, especially for lower earners, but it is still a net gain for the employee in each case.) The only way you lose is if you have a high income and high premiums (which means you live in an expensive area and your employer offers good benefits).

That actually looks like a big tax break, and it is: the Tax Policy Center estimated it would increase the deficit (or cost taxpayers) 1.3 trillion dollars over the next 10 years. Free money isn't cheap.

It is fair to criticize McCain's plan for burning another hole in the budget. It is also fair to point out that it is a tax change, not health care reform. It generally won't help the uninsured. And, perhaps most importantly, some people will lose in indirect ways. Employers will have no incentive to offer health benefits and some will surely choose to compete for workers by increasing wages and dropping health insurance. That means some people will lose their employer-provided insurance and some of those will get lost in the vagaries of the individual insurance market. The plan doesn't seem to provide adequate ways to deal with such risks.

It is even fair to point out that it is another instance of "more of the same" because Bush has been proposing a similar plan for the last two years. (By the way, it hasn't passed; why would McCain expect his plan to pass now that the Democrats are almost sure to fortify their control of Congress?)

But it is not fair to call it a tax increase.