Wednesday, February 25, 2009

Be Careful Not to Exaggerate

I am a believer in supply-side economics, but sometimes conservatives exaggerate its effects. There’s a little bit of this exaggeration in the criticisms I've read of the new Obama tax plan. Don’t get me wrong, it’s a bad idea and will only lead to less economic growth, but we are not going to plunge into a second recession from it alone.

From what I have read there are three major anti-growth tax changes that Obama wants to implement. First, is a hike in the marginal income tax rate for evil rich people. Not only do higher marginal provide a disincentive to work, but it also leads to less capital accumulation. The rate change, at least proposed, will move the highest marginal rate from 35% to 39.6%. If this were shooting up above 70% like under the Carter administration this would be a major concern. But, as is, it is only a slight negative effect.

Secondly, is the hike in the Capital Gains tax. This is the most moronic of all the tax hikes, as history has shown that cutting them down to 15% actually raised government revenue. This will have a more significant negative effect on capital flow into and out of the United States. However, changes in investment do not lead to immediate changes in the economy. This will be a long-term drag on the economy overall. However, the effects will be more immediate in the stock market.

Lastly, is forcing hedge funds to pay the corporate income tax rate instead of just the capital gains tax rate. Effectively what this says is that if you are an individual who invests one’s own money, you can pay the lower capital gains tax (15% soon to be 20%), but if you and your friends go into together you are now a corporation that needs to pay the higher corporate rate of 35%.

These changes are bad and they will lead to less economic growth, but the results will slowly build over time. If we were more sensitive to the tax competition they have in Europe the effects would be much bigger, but I don't think we are as sensitive to globalization as some would imagine.

Think of supply-side tax cuts this way: It’s like dieting. Cutting out the chips and sodas will lead to weight loss, but don’t expect to wake up the next morning looking like Brad Pitt.

Or the converse: It’s like me in college. I start off 5’11” and 130 lbs. As a carefree freshman, I laugh off suggestions about weight gain as I consume massive quantities of sodas, chips, and rolls of Pillsbury cookie dough. By the end of my sophomore year I’m pushing 175. Tax hikes always catch up to you, but only drastic changes show up quickly.


Anonymous said...

you forgot the most important tax of them all.. cap and trade. businesses don't pay taxes, they only pass them on to the consumer. taxing energy which is the lifeblood of our economy will only result in higher taxes for all of us!

Brian Shelley said...

I don't think that's a supply-side issue, but it is a good point nonetheless.