The Good and Bad of Obama's Tax Plan

“We are all blessed by the genius of relatively few.” – Warren Brookes, The Economy In Mind

Barack Obama’s top economic advisors, Jason Furman and Austan Goolsbee, summarized the main points of his tax plan last week in the Wall Street Journal. Most notably, rates of taxation on middle-class incomes will fall if his program passes, while federal rates on income and capital gains for top earners will return to levels last seen in the 1990s.

While Obama’s tax plan is mistaken, on its face it should not be seen in an apocalyptic light. In merely seeking a return to the taxation levels of the ‘90s, Obama is implicitly acknowledging that tax rates matter. While tax rates were too high in the ‘90s and they’re too high now, the ‘90s levels were relatively low when compared to the success penalties imposed by other 20th century U.S. presidents, and the economy grew.

In the above sense Obama is making plain that “we’re all Reaganites now.” Nowhere in his plan does he say we should return to the confiscatory rates weathered under Nixon, Ford and Carter in the ‘70s, or for that matter rates experienced under Ronald Reagan up until 1986. Reagan’s ideas about incentives and taxation seem to have positively infected both political parties to varying degrees, and this means there’s reason for moderate optimism no matter who wins in November.

Still, Obama’s tax plan is unfortunate because it flies in the face of his own objectives. Indeed, as Furman and Goolsbee noted, “Sen. Obama believes that one of the principle problems facing the economy today is the lack of discretionary income for middle-class wage earners.”

But if that’s the case, Obama won’t help the middle class by penalizing the wealthy. This is so because wages can only rise when the amount of available investment capital increases. Simply put, without capital there are no wages.

So while Furman and Goolsbee argue that “Obama’s middle-class tax cuts are larger than his partial rollbacks for families earning over $250,000,” they misunderstand the origin of middle-class comfort. In short, a 10% rate cut on income of $250,000 and up frees up far more capital than a tax cut on income of $50,000.

And that’s why it’s so essential to keep the rate of taxation on high earners as low as possible, perhaps the lowest rate of them all. From a revenue standpoint it’s empirically true that top earners footed a much greater portion of federal revenues in the 1920s, ‘60s and ‘80s despite a reduction in top rates, but more important is the impact on wages for those not wealthy.

Sure enough, logic tells us that if top earners are penalized less, they can either consume non-taxed income or they can save. If they consume we should consider their spending a non-Washington form of “stimulus” whereby the rich transfer wealth to workers through the purchase of life’s necessities and frivolities.

Even better, however, is what happens if the rich choose to save and invest the income that the government doesn’t confiscate. Invariably, money saved is lent to businesses and entrepreneurs reliant on capital in order to grow. For the middle class this is a big deal because the savings either fund new forms of employment, or additional remuneration. When Obama’s concerns about discretionary income are considered, the single best way to increase middle-class income is to reduce the success penalty on those in possession of the greatest amount of capital. That is the rich.

The above in mind, Furman and Goolsbee oddly maintain that the tax-rate cuts advocated by McCain “would take money from the middle class,” but as economic logic dictates, their assumptions are backwards. Any legislation that expands the dollar amount of non-taxed capital will automatically accrue to middle-class earnings. In short, don’t be fooled by candidates who say they’ll help the poor and middle class by taxing the rich. When politicians say the latter, what they’re really saying is that they’ll reduce the earnings of all those not yet rich.

And when we consider the blessings we all receive from the vital few who start businesses, it’s essential to remember that many of tomorrow’s corporate behemoths are presently small. According to Furman and Goolsbee, the “vast majority of small businesses would face lower taxes” under Obama’s plan, but this is deceptive. More realistically, many small businesses pay individual rates of taxation on profits, so while the Obama tax plan allegedly favors them, the reality is that an increase in the top tax rate will harm the very firms that Obama seeks to elevate.

Even worse, when Obama contradicts his alleged like of small business with proposals of higher taxes for same, he shows an impressive ignorance of how hard it is to make what is small, large. Indeed, the “seen” in the U.S. economy is the various economic success stories such as Microsoft and Google. What’s unseen is how many small businesses over the years have ceased to exist. With many reliant on the smallest of earnings margins to stay in operation, higher individual rates of taxation could constitute what is often the slight difference between success and failure.

The late Warren Brookes once noted that envy “is the single most impoverishing attitude of thought.” While the Obama tax plan in no way heralds future bread lines, it misses the point for needlessly furthering the politics of envy. Increased taxes on the rich will serve no helpful policy objective, but those taxes will weigh on the incomes of those who would one day like to be rich.