Myth of Obama tax cuts

As the nation’s attention is focused on whether Congress will extend the Bush tax cuts of 2001 and 2003, some are calling attention to the Obama tax cuts and calling for their extension.

These tax “cuts” — and I use quotes deliberately — are part of the stimulus bill passed in February 2009. Polls show that very people know of these tax cuts.

So what are the Obama tax cuts? There was one program that qualified — sort of — as a “cut,” and several tax credit programs. More information about these programs from the Obama Administration is at Recovery.gov,

The largest item that benefited most people is the Making Work Pay Tax Credit, a two-year program that rebates $400 per year to individual taxpayers, or $800 per year for married couples. This is not a reduction in marginal tax rates, although the program will reduce the average tax rate that people pay. At its core, it is simply a reduction in the overall amount of tax someone must pay.

This tax credit is not associated with any positive effort or activity by the recipients other than doing what they already do. The same criticism applies to the Bush tax rebate in 2008, too.

Besides the Making Work Pay Tax Credit, the Obama tax cuts consist of other tax credits that apply not to everyone, but only to people who qualify.

For example, a child care tax credit pays up to $1,200 per year in child care expenses. Obviously, the only people who can claim this credit are working people with children who chose to place them in daycare. Beyond that, it is not a “tax cut” by any stretch of the imagination. Properly, it is a spending program implemented through the tax system. Sometimes called tax expenditures, these measures often escape the usual scrutiny that spending receives. Since they’re billed as a “tax cut,” they sound like a good thing to most people, as few like paying taxes.

If we need any more evidence that these programs are really spending disguised as tax cuts, consider the description of the child care tax credit as provided by the Internal Revenue Service: “It is a refundable credit, which means taxpayers may receive refunds even when they do not owe any tax.”

That’s right. Even if you have no income tax liability, you can still get a tax credit — that is, a payment from the government.

For tax cuts to be productive in growing the economy, they have to be associated with something positive, namely with work, saving, or investment. What many people positively respond to is a reduction in marginal tax rates, that is, the tax that must be paid on the next dollar earned.

Programs that reduce the average tax rate like Obama’s Making Work Pay Tax Credit and the Bush tax rebates of 2008 aren’t effective because they don’t affect the marginal rate — the rate paid on the next dollar earned. This is not to say that I am not in favor of these programs. Anything that reduces the burden of taxes is welcome. But they are not the type of tax cuts that spur economic growth.

Who responds most positively to reductions in marginal tax rates? As Jeffrey A. Miron explains, it is the most economically productive members of society:

The Bush cuts provided lower taxes on ordinary income, especially for taxpayers at the high end of the income distribution. These are some of the most energetic and productive people in society; raising tax rates would discourage their effort and entrepreneurship. High-income taxpayers also have multiple ways of avoiding high tax rates, so any revenue gain from raising rates would be modest. The Bush cuts also lowered taxes on dividend and capital gains income; maintaining these lower rates is even more important for economic performance. Capital is mobile: when it is taxed heavily here, it flees somewhere else, meaning lower investment and employment in the United States. And because capital income taxes discourage investment or drive it overseas, they generate little if any tax revenue. (Jeffrey A. Miron, “Why the Bush Tax Cuts Worked”)

It is these “energetic and productive” people that are responsible for a great deal of business activity and job creation. When these people take steps to avoid taxes it means less productive economic activity and more unproductive tax shelters.

In Slaying Leviathan: The Moral Case for Tax Reform, author Leslie Carbone explains the harm of high marginal taxes, especially progressive taxes, where rates become higher as more income is earned:

The discouragement of earning money by working, saving, or investing inherent in any income tax is exacerbated by progressivity. While any high tax rates are economically destructive, high marginal rates are even worse, because high marginal rates particularly discourage productivity and inhibit economic growth. … By lowering potential pay off, high investment taxes especially discourage risky investment. Discouragement of risky investment squelches technological advancement, because new technologies are the most risky. This means our progressive tax system actually reduces progress and inhibits improve quality of life.”

If the goal of the Obama Administration is to create private sector economic growth instead of growth in government, it needs to keep the Bush tax cuts in place and avoid increases in marginal tax rates for everyone, especially the most productive members of society. A better strategy would be to reduce these tax rates farther to create even more economic growth.

There is a lesson to be learned locally, too. Kansas needs to cut its marginal tax rates, both for personal income and for corporations. Miron spoke of capital leaving the United States because of high taxes. It’s even easier for capital — and its accompanying jobs — to move from one U.S. state to another. States with low tax burdens are experiencing growth in jobs and population, while high tax states have losses in both areas. Kansas is in the middle of the pack, but moving in the wrong direction.

The current economic development strategy of Kansas and many of its cities and counties is to offer targeted incentives to attract new industry and keep current companies from leaving. A better strategy in the long run is to join the ranks of low tax burden states.


One thought on “Myth of Obama tax cuts”

  1. Thoughtful. You make a good case for effective tax strategy that causes the maximum gain to society, as opposed to tax expenditures that have less effect on people’s actions and decisions.

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