Tax Hike.
Dollars and Sense
Earlier this week, John McCain proposed temporarily slashing the capital gains tax rate from 15 percent to 7.5 percent for 2009 and 2010. Barack Obama supports raising the capital gains rate to 20 percent for individuals earning more than $200,000 a year and couples earning more than $250,000.
This is a bigger issue than many people realize. As UCLA economist Lee Ohanian points out, the U.S. capital stock is extremely sensitive to changes in capital income taxation. Before McCain called for a temporary reduction in the capital gains rate to 7.5 percent, Ohanian calculated what the McCain and Obama tax plans would mean for the capital stock. He did so when McCain was backing a 15 percent rate (the status quo). Ohanian estimated that in the long term, America’s capital stock would be “about 18 percent lower” under the Obama plan than it would be under the McCain plan. (Again, this was before McCain endorsed a temporary rate cut to 7.5 percent.)
“Taxing capital is not a good idea for anybody,” Ohanian told me. Indeed, a higher capital gains tax rate eventually translates into lower wages for the average worker. Over time, Ohanian says, the Obama plan “would reduce growth of wages and growth of GDP.”
In terms of individual income tax rates, Obama advocates lifting the highest rate from 35 percent to 39.6 percent and boosting the second highest rate from 33 percent to 36 percent. If such a tax hike were implemented, both the number of hours worked by top earners (many of them business owners) and the number of jobs created by those earners “would go down, perhaps considerably,” says Ohanian, citing evidence from Western Europe.
Obama frequently assures voters that he would only increase taxes on families and businesses with annual incomes above $250,000. But what would his tax plan mean for effective marginal tax rates? According to a report by the Tax Foundation, “Most low- and moderate-income couples would see their effective marginal tax rates rise, in some cases, significantly.” While the Obama plan “lowers taxes for the bottom four quintiles, marginal tax rates would fall only for the very lowest-income couples.”
Over time, says UCLA economist Lee Ohanian, the Obama plan ‘would reduce growth of wages and growth of GDP.’How is that? As the author of the study, Tax Foundation vice president and former Bush economic adviser Robert Carroll, explains, statutory tax rates and effective marginal tax rates are not the same thing. The effective marginal tax rate that households pay “is the amount that they pay in tax on their last dollar of income.”
McCain wants to make the Bush tax cuts permanent, and he also hopes to introduce a new health insurance tax credit ($2,500 for individuals and $5,000 for families). “His proposal to replace the exclusion for employer-based health insurance with a new health tax credit boosts taxpayers’ taxable incomes by their health insurance premiums,” says the Tax Foundation study, “which generally pushes taxpayers into higher tax brackets, but not to as great an extent as Senator Obama’s tax plan.”
On Social Security payroll taxes, Obama’s intentions remain uncertain. His campaign “has indicated that Social Security taxes might rise by 2 to 4 percent for taxpayers with earnings above $250,000.” If the Obama tax plan were implemented along with a 4 percent hike in Social Security taxes, the effective marginal tax rate for high-income earners could swell to 47.2 percent, according to the Tax Foundation.
Urban-Brookings Tax Policy Center economist Jeffrey Rohaly and researcher Katherine Lim have conducted their own analysis of what the McCain and Obama tax plans would mean for effective marginal tax rates. “In 2009,” they conclude, “Senator Obama’s plan would reduce the effective marginal tax rate for far more households than would the McCain plan. This is true both overall, and for all income classes.”
But whose plan would produce lower rates? “Overall, the Obama plan would leave average effective marginal tax rates virtually unchanged at 24 percent whereas the McCain plan would lower the average EMTR to 23 percent.” The Obama plan “would reduce average EMTRs dramatically” for households with annual cash incomes of less than $10,000 (in 2008 dollars) but increase average EMTRs markedly for households with annual cash incomes above $1 million. The McCain plan would not affect average EMTRs for either of these groups.
“The impact of the two plans on taxpayers in the middle would be more complicated,” Rohaly and Lim report. “On average, McCain’s plan would tend to lower effective marginal rates more than the Obama plan. McCain’s proposal does not contain the numerous phaseouts that the Obama plan uses to limit the benefits of tax credits to households with lower or moderate incomes. Nonetheless, the Obama plan would lower average EMTRs for those in the $50,000-$200,000 income class relative to current law.”
More specifically, Rohaly and Lim reckon that in 2009, households in the $30,000-$40,000 income class would pay an average EMTR of 16.8 percent under the McCain plan and 19 percent under the Obama plan. Households in the $50,000-$75,000 income class would pay an average EMTR of 18.6 percent under the McCain plan and 19.9 percent under the Obama plan. Households in the $100,000-$200,000 income class would pay an average EMTR of 25.1 percent under the McCain plan and 26 percent under the Obama plan.
What about corporate income taxes? McCain has suggested reducing the federal corporate tax rate from 35 percent to 25 percent. Harvard economist Greg Mankiw, a former Bush economic adviser, argues that this “ is perhaps the best simple recipe for promoting long-run growth in American living standards. ” As economist Zachary Karabell, president of River Twice Research , observes, it is precisely because the United States has such high corporate taxes relative to countries in Europe and Asia that “ even U.S.-listed companies that operate globally keep their profits outside the U.S., and thereby avoid those high taxes altogether. ” A recent National Bureau of Economic Research paper coauthored by economists at the World Bank and Harvard notes that higher corporate taxes “have a large and significant adverse effect on corporate investment and entrepreneurship” and “are also associated with a larger size of the informal sector, greater reliance on debt as opposed to equity finance, and slower economic growth.”
As for who shoulders the burden of corporate taxes, a 2006 study by Congressional Budget Office economist William Randolph found that “when capital is perfectly mobile and the tax does not affect the world prices of traded goods, domestic labor bears slightly more than 70 percent of the long-run burden of the corporate income tax.”
On capital gains taxes, effective marginal tax rates, and corporate taxes, the McCain campaign has a good case to make. But the Arizona senator has not made that case successfully. Indeed, less than three weeks before Election Day, McCain has yet to find his voice on the economy. That’s just one reason why his presidential bid is facing such long odds.