Scary Stuff

by hilzoy

John McCain recently outlined his economic platform (again), and it would be funny if he wasn't apparently quite serious about it. The fact that he is is terrifying. Here we are, in the middle of an economic meltdown, and one of our two nominees is someone whose ignorance of economics is truly boundless.

McCain proposes a whole raft of new tax cuts. I'll just outsource this one to Dean Baker, since he knows more than I do and writes very clearly:

"This year, Senator McCain pulled the best prank -- he proposed a huge tax break for Exxon and the other big oil companies. With a straight face he announced that he wanted to eliminate the gas tax during the summer driving season to save drivers money. Comedy gold!

Of course, we know that the price is determined by demand, because supply is constrained by the refinery capacity of Exxon and the other big oil companies.In other words, there is a fixed amount of supply, so the price will go as high as is necessary to eliminate any shortages.

If the price of gas is determined by demand, then what happens to the price when we eliminate the gas tax? That's right, absolutely nothing. The price will stay exactly the same, drivers will pay as much for gas during the summer driving season as they would have paid if the tax was left in place. The difference is that instead of 18.4 cents a gallon going to the government to pay for maintaining roads and bridges, this money will go to Exxon to keep CEO pay high, and make Exxon shareholders happier.

Senator McCain had more too. In addition to extending President Bush's tax cuts, he wants to cut the corporate tax rate from 35 percent to 25 percent, eliminate the alternative minimum tax, double the dependent exemption from $3,500 to $7,000, and give each newborn child a million dollars.

Okay, I made up the last one, but we're trying to get in the April Fools' spirit here along with Senator McCain. These tax cuts will cost in the range of $400 billion to $500 billion a year (13 percent to 16 percent of the budget), and Senator McCain has no way to pay for them, other than a one-year freeze on domestic discretionary spending. That can maybe get you $10 to $15 billion, but where is the rest of the money?"

But maybe Dean Baker is being just a tiny bit unfair to McCain. After all, he proposes to go after the scourge of earmarks! And as we all know, earmarks cost the government whole mansions full of pirate gold somewhere between $16.9 billion and $18.3 billion every year. Unless you adopt the definition McCain uses, in which case they cost all of $52.1 billion. This still leaves a cool $250-350 billion to be found elsewhere. Moreover, earmarks, so defined, turn out to include things like all our aid to Israel and Egypt, $6 billion in new military housing, "critical government construction efforts such as a new Federal Bureau of Investigation building in Los Angeles and 12 facilities aimed at assisting U.S. border patrol and customs officials in fully screening all cargo and individuals entering the country", "drug eradication funds for Colombia" (well, I'd go along with that one, but then I'm in favor of legalizing marijuana and adopting a demand-based approach to other illegal drugs), "two thirds of all foreign assistance", and lots of other fun stuff.

Personally, I think that there are two real problems with earmarks. The first has been largely fixed: that they need to be fully transparent. The second is that a lot of genuinely useful projects are funded via earmarks, and earmarks are generally a pretty lousy funding mechanism. There is no earthly reason why infrastructure projects shouldn't be funded according to actual need, instead of being largely funded through earmarks. But this is not an argument for defunding those projects; it's an argument for funding them via a different mechanism. Even using McCain's definition, cutting earmarks don't come close to funding his tax cuts; once we subtract out the genuinely useful programs that have the misfortune to be funded by this silly mechanism, the idea of paying for his tax cuts by cutting earmarks is risible.

To be fair, McCain also promises to eliminate "myriad corporate tax loopholes" which he doesn't specify, and to freeze discretionary spending for a year, "with the necessary exemption of military spending and veterans benefits" -- those same military people whose new housing he inadvertently proposed to eliminate. Whoop de do.

Steve Benen writes:

"There’s an embarrassing laziness in McCain’s approach to public policy. He starts with a broad, basic premise — in this case, earmarks are bad — and then ends with that that same basic premise. It probably never occurred to him to actually check what gets funded with earmarks, to see whether he’d want to make exceptions or not before making the public pledge."

And Scott Lilly wonders

"whether the shallow and sloppy work that went into the preparation of this latest economic plan is an aberration in an otherwise serious effort to have a serious debate about future policy choices facing the country, or emblematic of an approach to government in which the facts don’t matter."

Since McCain has, to the best of my knowledge, not said anything in the past few years that even remotely resembles a contribution to a serious debate about economic policy, I'm going with the second option. I don't think McCain knows much about economics. I see no sign that he cares to learn about it. That would be scary under any circumstances. Right now, though, it's terrifying.

Comments

[The Modesto Kid]

legalizing marijuana

What're ya, some kinda Libertarian?

(Nice post. McCain's repulsive.)

[Nell]

drug eradication funds for Colombia (well, I'd go along with [eliminating] that one...)

Especially given that that "drug eradication" is mass spraying of RoundUp over regular crop lands as well as coca fields, and air-based counterinsurgency attacks under cover of 'war on drugs'.

Conducted by DynCorp, a private military company as pernicious as Blackwater.

[Hartmut]

Well, all the magical ponies should be sellable with big enough a profit to pay for all that and if the yellow moneylending flying monkeys and the oily ragheads (pardon, our revered East Asian and Middle Eastern trade partners) are not content with them, there should be a few ports, banks, and industries that can serve as (of course temporal) security. Hasn't St.Ronny brought us the divine wisdom that deficits don't matter? You can't leave the sellout of the country to those taxvampiric Demon-rats, especially not the [n-word] and the [c-word].
[/retch]

[Free Lunch]

Don't you know that St. Ronnie proved that you can spend all the money you want without collecting taxes. McCain is just taking this absurd proposition a step beyond the awe-inspiring foolishness of George W Bush. The next Republican candidate will naturally come to the conclusion that all taxes should be eliminated and the entire government will be paid for by borrowing.

[Jay Jerome]

hilzoy: "The fact that he is is terrifying. Here we are, in the middle of an economic meltdown, and one of our two nominees is someone whose ignorance of economics is truly boundless."

Two nominees? Really? I though there was one 'presumptive' nominee and two 'contesting' candidates...

Of the two 'contesting' Democrats, Obama appears to be the duller blade when it comes to understanding economics. He doesn't even have a grip on recent economic history: his misstatement in his 'bitter' comment, for instance, when he said that small towns in the Midwest have been gone for 25 years, and "they fell through the Clinton administration, and the Bush administration."

Aside from the fact that it was an uncalled for slap at the Clintons (Obamaniacs conveniently overlook it in their sob-story complaint about the unfair criticism Obama's bitter remarks evoked from Hillery supporters) it's dead wrong.

As pointed out in Paul Krugman's NY Times column on April 18th, "In fact, the Clinton years were very good for working Americans in the Midwest, where real median household income soared before crashing after 2000."

Krugman has a link to the figures on his blog, which shows that the Midwest benefited, as did the rest of the nation.

If Barak's this blurry about his own party's economic success during the Clinton era (more jobs, more money in working class pockets) it doesn't speak well for his overall economic understanding of the past, or bode well for his ability to address the nation's economic future.

[Jay C]

And Scott Lilly wonders

"whether the shallow and sloppy work that went into the preparation of this latest economic plan is an aberration in an otherwise serious effort to have a serious debate about future policy choices facing the country, or emblematic of an approach to government in which the facts don’t matter."

Well, Duhhh! This is a political campaign - of course "facts" don't matter!!

[OCSteve]

This is not to say that I agree with McCain on all this (some I do and some I don’t) but none of the candidates really shine in this area. McCain sets himself up as an easy target, but it would be helpful if someone can explain how the other two are any better.

Obama has the middle class pegged at $200-$250k and promises he won’t raise taxes on anyone making less. But that then leaves him without the revenue to pay for all his other promises. But then he does raise taxes on the middle class via raising the social security cap and almost doubling the capital gains tax. He’s going to break his promise to the middle class and still not be able to deliver on his other promises, which amount to a massive amount of new spending. (And he just got clobbered in that last debate on the capital gains topic.)

HRC wants to micro-manage the economy using tax and regulatory policies to promote those sectors she believes are important. She’s also proposing massive new spending.

Neither D candidate has given much in the way of specifics concerning how they will pay for it all. They talk about money saved from ending the war – but that is deficit spending now. McCain is the only one even talking about cutting back spending.

I really don’t see much difference between proposing massive new spending without a way to pay for it all and proposing tax cuts without a way to make up the difference. The outcome is the same. I’m not an economist either, but I know if I make $1,000 less next year I have to figure out where to cut $1,000 in expenses, and if I want to spend $1,000 more next year I better figure out how to make another $1,000.

In reality, thankfully, any of them will be at least somewhat constrained by Congress.

[Turbulence]

This is not to say that I agree with McCain on all this (some I do and some I don’t) but none of the candidates really shine in this area. McCain sets himself up as an easy target, but it would be helpful if someone can explain how the other two are any better.

Well let's see: on the one hand, we have a doddering old fool who believes the Laffer delusions. To me, that makes McCain literally insane. On the other hand we have two respected Democrats. Clinton's husband did a fairly good job on the economy: he seemed at least as skilled in that regard as any other President we've had in the last 30 years. That doesn't tell us anything conclusive about how she would run the economy, but it does suggest that this scaremongering about strangling the economy with regulation is a bit overblown (or undersubstantiated). Obama doesn't have crazy religious beliefs about how cutting taxes magically produces more revenue, plus he's got fairly sane Democratic advisers on the economy, many of whom were involved in Clinton I's fairly sane economic policies.

I don't think this is a hard decision. I'm not saying that Clinton and Obama will be great on the economy, I'm just saying they don't believe in the most laughable economic fairy tales of our generation, which McCain does. That makes the choice easy, if not guaranteed to be pleasant.

[mightygodking]

(And he just got clobbered in that last debate on the capital gains topic.)

Probably because he wasn't expecting Charles Gibson to be either incredibly stupid or flagrantly dishonest. The entire Obama campaign has been a pattern of counterpunching: get sidelined by relatively stupid non-issue or false characterization of issue, then respond forcefully with actual truth and gain back all losses plus a couple points. I don't see why this should change for capital gains - give it a week.

[farmgirl]

OC, do you have a philisophical objection to taxing capital gains at the same rates as earnings, or are you just pointing out an inconsistency?

[Anthony Damiani]

Thank you for not continuing the fiction that we have three viable candidates at this point.

[John J.]

Great post. Batocchio sent me over here.

The best part of the tax holiday McCain proposes, imo, is that even if it did result in gas prices dropping 18 cents, the total the average family would save over the three months is less than the cost of one fill up.

As far as capital gains tax and Obama, I don't have the numbers in front of me, but most middle income families that invest in the stock market do so for long term goals, generally retirement or college. The capital gains tax is only applied when you take money out of your investments. Thus, if capital gains taxes were increased to match income taxes, that increase would apply to those people who use their investments as income. Obama already intends to create tax deductions for college spending, so half of what most middle income families pay for with their investments will have taxes reduced and when you take the money out during retirement, you generally aren't making other income and so still fall under standard deduction level. Now, I'm not an economist, but that looks like a very targeted increase in taxes on those in the top 10% of income earners.

[Ara]

farmgirl: I am beginning to wonder if I have a philosophical objection to taxing capital gains at the same rate as earnings. Here are the two things I think about it:

(1) Capital gains currently doesn't adjust for inflation. So the real capital gains tax rate is already a little higher than the nominal rate.

(2) I'm guessing that a hike in the capital gains rate is actually more regressive than progressive, with the exception of a very select class of wealthy people that keep getting singled out. Here's why: I would bet you most people post there single largest capital gain when they sell their house. My hunch is that a person who makes $300,000 selling a house they bought twenty years ago is likely not as affluent as a person who makes $300,000 a year as income. And given that, they ought to be taxed differently.

[OCSteve]

Turb: Clinton's husband did a fairly good job on the economy: he seemed at least as skilled in that regard as any other President we've had in the last 30 years.

I’ll actually agree with this. I’m not sure it was skill and knowledge vs. just a lucky break, but I’ll still agree.

On the rest I better pass. Or you’ll find me to be a doddering old fool with delusions and literally insane. ;)

mightygodking: Probably because he wasn't expecting Charles Gibson to be either incredibly stupid or flagrantly dishonest.

Curious – what part was wrong much less stupid or dishonest?

Farmgirl: do you have a philisophical objection to taxing capital gains at the same rates as earnings, or are you just pointing out an inconsistency?

Some of each. It’s inconsistent to say he will spare the middle class from any tax hike yet also raise the cap on FISA and double the capital gains tax. The generation still working now for the most part does not have a company paid pension plan. We are on our own. And that means stocks and 401(k)’s and IRA’s etc. It is not just the super rich anymore – a lot of us have a piece of the stock market. He tries to paint it as going after those evil Wall Street types – but it impacts many more people than that. On the philosophical point – yes, I believe that lower capital gains = more investment = more jobs = more spreading the wealth.

[OCSteve]

Ara: I’m pretty sure you can sell your primary residence (where you live most of the year) every 5 years without paying a capital gains tax. That only comes into play if you are flipping properties etc.

I hate to say that, as your comment bolstered mine nicely, but… ;)

[russell]

Ara -

I'm not sure I'm understanding your points correctly.

Wage earnings don't automatically adjust for inflation either, unless you work under a contract that specifically states that they will. Most people don't work under a contract like that.

Most folks that sell their homes, at least in the category of folks you're referring to in your example, don't pay capital gains on the sale of their homes because they either roll them over into a new home, or they use the money to fund retirement. Both of those uses are, IIRC, exempt from a capital gains tax.

Am I missing something?

Thanks -

[rea]

Capital gains currently doesn't adjust for inflation. So the real capital gains tax rate is already a little higher than the nominal rate.

I'm not sure I understand you--don't the dollars in which you pay the tax inflate at the same rate as the dollars in which you earn capital gains?

[Ara]

Is it true that the supply is fixed by refinery capacity (and that that capacity is now fully utilized)?

I was under the impression that this is true on the short-run (6-9 months).

[Ara]

russell: I was thinking of people whose homes *were* their retirement, so they weren't rolling over. And they weren't funding any retirement plan with it.

In any case, I'm *utterly* wrong, as OCSteve pointed out. It turns out that there is a pretty hefty 250k - 500k exemption on principle residences, owing to a 1997 law. I take it back. Thanks and sorry, everyone.

[OCSteve]

Here is an IBD editorial that hard-core Obama supporters will not like (they slap him around pretty good), but they do throw out some stats:

Apparently, Obama doesn't know that 52% of all adults now own stock — so raising the capital gains rate from 15% to 28% would hit millions of people with incomes below $200,000.

That includes, by the way, the secretary of those hedge fund managers, who likely owns stock herself. She'll really feel the brunt.

Indeed, data from Congress' Joint Committee on Taxation show 20% of those with capital gains in 2005 had annual incomes less than $50,000. So Obama's "tax-the-rich" plan to jack up cap gains rates would in fact become a huge middle-class tax hike.

Add to this his idea to lift the Social Security tax cap on incomes above $97,000, which would hit many of the same people, and you get the idea that Obama doesn't understand economics at all.

[Turbulence]

I’ll actually agree with this. I’m not sure it was skill and knowledge vs. just a lucky break, but I’ll still agree.

Well, I'll actually agree with that. I think both luck and skill played nontrivial roles.

On the rest I better pass. Or you’ll find me to be a doddering old fool with delusions and literally insane. ;)

The Laffer curve is the most hilarious fairy tale ever! Laffer wants to jot down on a napkin a graph showing expected government revenues as a function of tax rate. Except he only knows two points: 0% tax gives zero revenues and 100% tax gives zero revenues. So he reasons that there must be a curve that connects those two points and that that curve MUST be simple and concave because ZOMG IT WOULD BE SO AWESOME IF IT WERE TRUE THE MAGICAL TAX PONIES WILL SAVE US!11!

Of course, real economists don't believe the curve is simple. But it gets better. Even if you believed Laffer's economic wish fulfillment religion, his theory tell us nothing about where the peak of the curve is. The peak matters because if your tax rate is below the peak, then raising taxes brings in more money while lowering taxes loses money. The magical fairy land where cutting taxes increases revenue only happens when you're tax rate is above the peak, but there's no reason whatsoever to believe that our tax rates are above the peak.

Just like his foreign policy ideas, McCain's economic ideas look patently stupid when you strip away the obfuscation.

[russell]

I believe that lower capital gains = more investment = more jobs = more spreading the wealth.

This is a pretty common point of view, and it seems to make sense on it's face. If you lower the cost of investing (by lowering the tax on it), you'll increase the incentive to invest, thus increasing the capital pool, so overall wealth increases, which is good for everyone.

You could reverse it. By lowering taxes on wage income, you increase the incentive to work, and so more labor is available, so wealth increases. Nobody ever makes that argument, so I assume there's some reason to think it's implausible.

What is that reason? Is scarcity of capital known to be a greater impediment to the creation of wealth than scarcity of labor? The answer could be yes, I just don't know.

Also, if folks decide not to invest their money in capital markets because of the capital gain tax, what do they do with it instead?

Do those other uses tend to create less wealth overall? Are they otherwise less desirable from a public policy point of view?

I'm not saying there isn't something to your argument here, because I just don't know. I'm just wondering what the actual benefit is to treating unearned income preferentially.

Thanks -

[Ara]

russell: I guess the way to put it is this. If in one year, I own and sell an asset that has nominal gain of 4%, I'll be paying a capital gains tax on it, even though inflation in that year might have been 4% or even higher. That is, I'll be paying a capital gains tax even on an investment that was break-even (making it a loss). If inflation is higher than that, I'm paying a capital gains tax on an investment that was a loss.

[Ara]

russell: You can reverse it by arguing that lowering taxes on consumers will increase business receipts and that *that* will spur investment, regardless of the capital gains rate. I assume that whichever tool is a better micro-tool to address economic needs varies depending on where spending shortfalls are at the moment.

As for scarcity of capital versus labor or demand, *right now* that might be a bigger problem. Sallie Mae is holding off on its student loans! But in general over the last 25 years, no.

[Turbulence]

Apparently, Obama doesn't know that 52% of all adults now own stock — so raising the capital gains rate from 15% to 28% would hit millions of people with incomes below $200,000.

What is this wankery? Knowing that lots of people own stock does not tell us whether their will be a non-negligible tax hit for middle class people. Many many people own a small number of shares: given the fact that America's savings rate is negative and given the fact that most middle class people store a large chunk of their wealth in real estate, it seems unlikely that this will make a significant impact on middle class people.

Also, where I come from, 200K worth of income is a pretty large chunk of change. If you want to make this argument seriously, you'd need to describe what the expected annual tax hike would be for a family with median earnings, wealth and a asset distribution.

Oh, and you only pay capital gains when you make money. Many, many people do not make money on stocks. I would wager that lower income folk disproportionately lose money because they lack sophisticated financial advice and because they're often "encouraged" to purchase their own company's stock even though it is a bad idea. I imagine that Enron employees are not particularly bitter about all those capital gains taxes they had to pay for...

Indeed, data from Congress' Joint Committee on Taxation show 20% of those with capital gains in 2005 had annual incomes less than $50,000. So Obama's "tax-the-rich" plan to jack up cap gains rates would in fact become a huge middle-class tax hike.

Again, these numbers are useless if you don't tell us what the expected tax hit is for these people.

Add to this his idea to lift the Social Security tax cap on incomes above $97,000, which would hit many of the same people, and you get the idea that Obama doesn't understand economics at all.

This is insane. Only 6% of earners have an income of 100K or more per year. Those people are already being taxed on the first 97%; the idea that there is large number of people who are going to have pay a great deal more but who can't afford the difference is just ludicrous.

[Ara]

Turbulence: Yeah, I wish there were some numbers not on how many people owned stock (rather unimportant), but on what percentage of stock was owned by what percentage of households. Like a Lorentz curve for stock ownership.

[Morat20]

Most Americans "own stock" in the form of their 401ks. Which are, indeed taxed upon withdrawal.

But they are not taxed as capital gains.

I'd LOVE to see what sort of "capital gains" those 50k a year income folks have. In fact, I'd love to hear what they call "income". I've see similar claims where, when you track it down, people making millions a year off stock were considered to have no "income" -- just capital gains.

[russell]

If in one year, I own and sell an asset that has nominal gain of 4%, I'll be paying a capital gains tax on it, even though inflation in that year might have been 4% or even higher.

OK, I follow you now. That makes sense. Thanks for the explanation, I appreciate it.

You can reverse it by arguing that lowering taxes on consumers will increase business receipts and that *that* will spur investment, regardless of the capital gains rate.

That's a good point, but it isn't really where I was going.

There are basically two ingredients involved in the creation of value and wealth: capital and labor. A preferential tax rate for capital investment assumes that it's more valuable, overall, to encourage capital investment, and less valuable to encourage labor.

Is that true? If so, why?

People actually don't have to work at jobs that result in them paying taxes. They can work off the books, or, in some cases, not work at all. If the tax on earned income is high enough, the alternatives become attractive, and it becomes hard to find workers, period.

Conversely, the argument goes that if the tax on unearned income is high enough, folks just won't invest their money. What do they do instead? Do they just let it sit in the bank?

It might be that it's more useful overall to tax capital gains preferentially, but I've never seen the case actually made in any substantive terms. It just seems to be assumed.

Thanks -

[OCSteve]

Turb: Just like his foreign policy ideas, McCain's economic ideas look patently stupid when you strip away the obfuscation.

Don’t they all? What am I missing? Seriously – I am prepared to read something in support of Obama’s or HRC’s economic proposals that makes one lick of sense. You know I can take being proven wrong – so show me…

russell: 15% vs. 28%. At 15% my discretionary income could go into a high risk investment which could generate jobs, resulting in more revenue to the government overall. At 28% - not so much. I’ll find some other financial vehicle.

Turb: Well, I said you wouldn’t like it…

[OCSteve]

It’s like this IMO:

Let’s play rock paper scissors, or flip a coin, or whatever you want. You bet a lot of money - enough to really hurt if you lost it all.

If you lose, you lose every penny, and probably more than you originally bet.

If you win – I still get 28% of your winnings.

[Turbulence]

Don’t they all? What am I missing? Seriously – I am prepared to read something in support of Obama’s or HRC’s economic proposals that makes one lick of sense.

I'll take technocratic competency over McCain's wish fulfillment any day.

15% vs. 28%. At 15% my discretionary income could go into a high risk investment which could generate jobs, resulting in more revenue to the government overall. At 28% - not so much. I’ll find some other financial vehicle.

Huh? Isn't this just the Laffer curve argument all over again? If so, can you explain why that argument is valid? I mean, its not just me who thinks it is stupid: the chairman of the President's council of economic advisers shares that opinion as well.

[Turbulence]

15% vs. 28%. At 15% my discretionary income could go into a high risk investment which could generate jobs, resulting in more revenue to the government overall. At 28% - not so much. I’ll find some other financial vehicle.

No, no you won't. What other investment vehicle do you plan on putting your money in that has a comparable rate of return to equities after adjusting for capital gains tax increases? Most other asset classes also count as capital gains. Most middle class people who invest do so with 401Ks and won't be paying capital gains on those returns ever.

[mightygodking]

Curious – what part was wrong much less stupid or dishonest?

Gibson complaining that when capital gains taxes are reduced, overall revenue increases. It's technically true, because what happens is people put off sales that would be capital-gains-taxed until the tax decrease takes effect, and then you get an illusory "revenue gain" that isn't really a revenue gain in any longterm sense (which is what Gibson either thinks or wants you to think). More at the Plank - also, read Dean Baker.

Gibson didn't say "some people believe that capital gains tax reduction increases revenue generation." He asserted it as fact, and he is simply wrong. That means he is either ignorant or lying - take your pick.

[Phil]

If you win – I still get 28% of your winnings.

Yes, but you'll also provide needed infrastructure at taxpayer expense, enforce my contracts, provide a secure market for my business dealings, etc.

[Bernard Yomtov]

15% vs. 28%. At 15% my discretionary income could go into a high risk investment which could generate jobs, resulting in more revenue to the government overall. At 28% - not so much. I’ll find some other financial vehicle.

Yes, this is just another version of Laffer. But why are high-risk investments better somehow than other vehicles? Say you put the money in a savings account. Well, the bank is going to lend that money out to someone, and that loan might create jobs as well.

[OCSteve]

Turb: I'll take technocratic competency over McCain's wish fulfillment any day.

Well that’s what I’m looking for – because to me - $200B+ in new spending without saying where you get the $ is looking for a pony – no, a Unicorn. Show me the money…

If so, can you explain why that argument is valid?

Not in a logical sense or with links that could prove I’m correct. Just my opinion. I would be more likely to risk a lot for a 15% bite than a 28% bite. Why the hell should I take the risk when the government just sits back and collects 28% of anything I make? I’ll put it in a money market or CD making 3% first… And yeah – some or a lot of that is pure spite.

mightygodking: Gibson didn't say "some people believe that capital gains tax reduction increases revenue generation." He asserted it as fact, and he is simply wrong. That means he is either ignorant or lying - take your pick.

How is he “simply wrong”? I read your links. I don’t see it disproved… So if I don’t agree with you I am ignorant or lying. I guess I prefer lying over ignorant…

Phil: Yes, but you'll also provide needed infrastructure at taxpayer expense, enforce my contracts, provide a secure market for my business dealings, etc.

A good and valid point, but it still comes down to this: should the government speculate with taxpayer’s money? Or should the government offer a break to private citizens who are willing to risk their own money? Pick one.

[Turbulence]

Not in a logical sense or with links that could prove I’m correct. Just my opinion. I would be more likely to risk a lot for a 15% bite than a 28% bite.

Ah, an opinion. OK then.

Why the hell should I take the risk when the government just sits back and collects 28% of anything I make? I’ll put it in a money market or CD making 3% first… And yeah – some or a lot of that is pure spite.

Because at 3% you're money is just barely keeping pace with inflation, so your inflation adjusted return is 0% (roughly). Put your money in the stock market for the long haul and you're looking at more like 4-6%: whether you knock of 15% of that profit or 28% of that profit, you still end up with more money. Now, you may decide that the increment from 15% to 28% is so morally outrageous that you refuse to invest in the stock market out of sheer spite. That's your call to make, but I'd argue that you'd be losing money that way.

That's why I asked you what other investment vehicles you thought would do better. Savings accounts are not going to do it.

[OCSteve]

Ah, an opinion. OK then.

Jeeze dude – everything I say is an opinion. How is this different? Did I forget to say “IMO” enough?

It’s like this: I work for a small company. The principals risked all that they had. Mortgaged their homes, put their kids future at risk, the whole nine yards. They risked everything they had including their children’s’ welfare. Now they employ 50 people and the tax revenue from that is pretty significant. Not just federal, but state and local. These folks pay a local tax for the privilege of dragging their ass out of bed every morning and going to work in this particular township.

Private parties should be encouraged to take some risk – not penalized for it.

[russell]

russell: 15% vs. 28%. At 15% my discretionary income could go into a high risk investment which could generate jobs, resulting in more revenue to the government overall.

The difference here seems to be the level of risk you will tolerate, not whether you'll invest at all.

It's not clear to me that high risk investments create more jobs and/or more return the the federal coffer than lower risk investments. They generally make more money for someone, but I'm not sure that's always equal to jobs or tax revenue.

I actually know a generous handful of entrepreneurs, and some of them are amazingly skillful at pissing investment capital away. When they hit, they hit, and some folks make a lot of money, but that doesn't always translate to lots of jobs. And when they don't hit, that's capital down the drain.

The flip side:

At the minimal effective tax rate that actually applies to earned income at the lower brackets, it might make sense for me to work on the books at a factory, service, or entry level job.

If the rate was higher, I might prefer to clean houses or watch other people's kids for cash. I can tell for damned sure that I know people that make that decision with tax rates what they are now.

Taxing unearned income at a preferential rate assumes that, overall, some greater public good derives from investing capital than from labor. That seems to be a pretty common assumption, but I've never actually seen it demonstrated.

If anyone can demonstrate it, I'd love to see it.

Thanks -

[OCSteve]

Have a good weekend folks. There are some signs of spring around here and I am *not* going to spend the weekend on the ‘tubes. You all are free to be wrong ALL weekend…

;)

Have a good trip home hilzoy. You are the Internet’s most important asset. Take care of yourself.

[Turbulence]

Jeeze dude – everything I say is an opinion. How is this different? Did I forget to say “IMO” enough?

Sorry; I didn't mean to offend. Sometimes you say crazy things and are prepared to justify them with logic and cites and sometimes you say crazy things with no intention of justifying. I was just noting that this statement was in category 2 rather than 1. Again, I meant no offense. ;-)

I work for a small company. The principals risked all that they had. Mortgaged their homes, put their kids future at risk, the whole nine yards. They risked everything they had including their children’s’ welfare. Now they employ 50 people and the tax revenue from that is pretty significant.

Man, that was stupid of them. I think people who jeopardize their children's future are, um, not good. Most small businesses fail. Most small businessmen dramatically overestimate their business ability, technical skills, and market demand. That's why if you're not able to convince someone else that your company is a good investment for their money, well, maybe it is not such a good idea. Now, obviously, sometimes new ventures go great: those tend to be the companies that end up hiring people because companies that have gone out of business can't afford many employees. Nevertheless, the old business school advice about how you shouldn't start a business if failing will completely destroy you remains sound.

Private parties should be encouraged to take some risk – not penalized for it.

Really? All risk? We should encourage people to take risks no matter what? I don't think that's a good general principle.

Instead, I would suggest moderation in all things. We should not encourage risk beyond a certain point for two reasons. First, risks impose negative externalities: many risks are socialized while the corresponding rewards are privatized (hi LTCM!). Our economy is experiencing severe distress because the securitization industry lost all sanity taking "risks".

Secondly, much risk doesn't actually have positive externalities. There is a limit to how much useful investment our economy can support at any given time; investing beyond that point just feeds speculative bubbles and all manner of financial malfeasance. Is the economy really better off due to the valiant efforts of all those speculators? I mean, look at what the house flippers accomplished: they got some extra cash, they helped drive up prices and overfed the asset bubble, and they helped bring about a massive collapse in housing and credit markets, in the process destroying a trillion dollars of wealth. This does not seem good to me. DO NOT WANT!

[Ara]

OCSteve: Two things. I've seen some more complete articles on the "unfreezing" effect of capital gains tax cuts, where people unlock their assets in the first few years, making the rates spike, and, afterwards, the baseline falls.

I'm hazy on some of it but another counterargument is this: the Laffer curve is a macroeconomic idea, namely the idea that lowering rates is going to fuel a growth in GDP. But a change in tax policy need not have such macroeconomic consequences. It can, for example, change investment choices. The idea here is that if one vehicle is taxed at a favorable rate, it will cause people to move into that vehicle. Revenues from that tax will shoot up, but overall tax revenues would presumably decline, because people are simply opting towards the tax structure that lets them pay the least. And so, the idea that lowering the rates somehow contributed spectacularly to growth is illusory.

I feel your pain on the capital gains tax distorting the risk-reward for investment. But my other response to it is: so what? I mean, any tax structure at all is going to influence incentives to work, invest, and so forth. We have to set the rates *somewhere*.

[russell]

They risked everything they had including their children’s’ welfare.

People do the same when they decide where and how they will invest their labor.

Here's my point:

The government taxes unearned income at a standard rate, regardless of your total overall income. That rate is significantly lower than most earned income rates, especially considering that the folks who are most likely to be capital investors are the higher bracket earners.

The rationale for doing this is that they want to encourage capital investment. If you're at a 28% tax bracket, the feds think it's about twice as valuable for you to invest your money than it is for you to work. This is expressed very concretely by their taxing you about twice as much for every dollar you earn by your labor, as compared to every dollar you accrue as a return on a capital investment.

What, as a matter of public policy, is the basis for that decision?

I assume that there is a reason for the apparently widespread belief that capital investment is, overall, of greater public value than labor, but noone has ever made that reason clear to me.

Can anyone here take a stab at it?

Thanks -

[hilzoy]

JJ: All I meant about nominees was this: I could have said "one of the three candidates", but I wanted to say something stronger, namely: that McCain was going to end up as one of the two nominees. The opportunity to knock him out of the GOP race on the grounds of his economic incompetence are over (and it's not as though the rest were better.) So I said what I said. I did not say, because I did not mean, that the identity of the other nominee is known. It's pretty clear who it will be, the math being what it is, but I didn't actually name Obama because he hasn't locked it up yet.

OCSteve: Thanks, and have a nice weekend. On the off chance you're still reading, despite your best intentions: I think there are things the Dems are proposing that would increase people's willingness to take risks. The most important is providing health insurance.

Right now, your boss had to risk everything knowing not just that if s/he guessed wrong, all would be lost, but also that if s/he, or a member of his/her family, got sick, the medical bills would ruin everything. (Assuming s/he used to get health insurance from a previous employer, and/or would have done so had s/he taken a salaried job rather than being an entrepreneur. If s/he had insurance through the VA, all might be different. But not everyone is a vet.)

Starting a business normally involves either going without health insurance or buying it on the ruinously expensive individual market, which is unaffordable for a lot of people who might otherwise be really great entrepreneurs. This is a huge disincentive to becoming an entrepreneur, especially for people with kids: I know I would be much, much more comfortable risking my own health than risking my kids', if I had kids.

I have precisely zero figures on this one, but I would bet a significant sum that the increased entrepreneurship that comes with providing health insurance is greater than the decrease from the proposed increase in cap. gains.

Also: in general, when people talk about running deficits, it matters a lot what you're spending the money on. Individually, going into debt to buy a house is way different than going into debt to buy several hundred thousand dollars worth of DVDs. Likewise collectively. I am not, right now, in a position to research Obama's plans to pay for stuff, but I think what he plans to spend the money on is targeted to actual lower- and middle-income people, whereas McCain's is targeted overwhelmingly at the very rich. Plus, as I said, some of what he's proposing (health care) would also increase entrepreneurship, with the delightful side benefit of providing health insurance to people, and saving them from having their savings wiped out if they get sick.

Have a nice weekend!

[mightygodking]

How is he “simply wrong”? I read your links. I don’t see it disproved… So if I don’t agree with you I am ignorant or lying. I guess I prefer lying over ignorant…

Steve, you're not asserting something that, at best, is an economic theory with little to no evidence to back it up is proven fact. Gibson did.

Therein lies the difference. I might not agree with you, but you're not saying "look, the argument's over, this is how it is." Gibson did precisely that, as part of a concerted attempt to ambush Obama.

Ignorant or dishonest.

(And really, if Dean Baker says that basic economic history contradicts the argument, I'm going to trust the award-winning economist on basic economic history more than I trust Charles "$200,000 is middle class" Gibson.)

[sleepy]

"I don't think McCain knows much about economics."

this is a ridiculous conclusion to draw. he knows exactly what he's proposing. he's just told you in detail. he wants to rob you blind. both major parties have been doing it for some time. oh yes, they know a thing or two about economics.

[majun]

I wish people would pay more attention to what earmarks really are. Earmarks are not appropriations, they do not add one dime to overall federal spending authority. They are allocations of already appropriated funds. In other words some Congressman earmarks $100,000 to support a study being done at the Brooklyn Upper Level Laser Shifting Halfbaked Institute of Technology, he is not adding $100,000 to the federal budget for the BULLSHIT study, he is merely telling some agency, like the Department of Defense, that they have to allocate $100,000 of their 500 billion dollar budget to the BULLSHIT study. Things being the way they are at DoD these days, with all the private contracts for Iraq, spending $100,000 on some BULLSHIT study doesn't really seem like that much of a waste, now does it?

So eliminating earmarks won't save any money, just take the spending decisions out of the hands of democratically elected representatives, who are paying off their large campaign doners, and put it into the hands of political appointees who pay for their appointments with large campaign donations, thus eliminating the middle man.

[Anarch]

Turbulence: If you're lucky, von will come by to defend the Laffer curve in a sec. I'm done with that particular argument myself but you should feel free to enjoy :)

[russell]

I'm going to risk making the leap from merely annoying to truly obnoxious and ask my question upthread again:

What is the virtue of incentivizing capital investment, but not labor?

OC's bosses put their personal fortune at risk to start up their company.

Skilled workers often put *their* financial health and careers at risk to join startups.

What's the difference?

Why should a research scientist leave a cushy university position to join a private firm, if 1/3 of his new improved salary will be taxed away?

The woman who cleans our house is hard-working, incredibly detail oriented, and totally customer focussed. We pay her in cash, and we have no idea what she declares. Let's pretend she does not declare her income.

She'd be a huge asset to any place she might work for. Why would she ever stop cleaning houses and go work for someone else, if as a result (presumably) her salary would then be taxed?

As a matter of public policy, we tax unearned income at a relatively lower rate than earned income. That appears to be based on a belief that encouraging capital formation leads to an overall growth in the economy and greater wealth.

Why just capital?

Is capital enough to build a business and create value, or is labor also necessary?

Why is it worth our while to encourage entrepreneurial risk-taking with capital, but not with labor?

I'm assuming there is a reason behind this -- some economic principle -- but I've never heard it articulated.

Thanks -

[Bernard Yomtov]

If in one year, I own and sell an asset that has nominal gain of 4%, I'll be paying a capital gains tax on it, even though inflation in that year might have been 4% or even higher. That is, I'll be paying a capital gains tax even on an investment that was break-even (making it a loss). If inflation is higher than that, I'm paying a capital gains tax on an investment that was a loss.

This is true, but let's remember that the same thing applies to other investments as well. If you invest in a money-market fund and collect 5% interest, with inflation at 4%, you are losing money in real terms also. The tax advantage of stocks, aside from the lower CG rate, is that you only pay the tax when the gain is realized, so the value can grow, untaxed, for many years. Depending, obviously, on the numbers, this deferral privilege can easily be worth much more than the inflation costs.

[Gromit]

Today on "This Week", to demonstrate how "out of touch" Obama is on economic issues, Mccain said the following:

Senator Obama says that he doesn’t want to raise taxes on anybody over — making over $200,000 a year, yet he wants to nearly double the capital gains tax. Nearly double it, which 100 million Americans have investments in — mutual funds, 401(k)s — policemen, firemen, nurses. He wants to increase their taxes.

Someone please help me if I'm missing his point altogether, but it's my understanding (and this understanding is backed up by every reference I can google on the topic) that 401(k)'s, including the gains on the investments, are taxed as ordinary income on withdrawal. Meaning that increasing the long-term capital gains tax rate will have zero effect on those who invest in these vehicles. In fact, some advisors caution against maxing out your 401(k) for this very reason.

What's worse, George Stephanopolous, who was doing an otherwise respectable job of grilling McCain on his economic magical thinking, didn't call him on it. Moreover, when George Will raised the issue repeatedly later in the show, hilighting it as a huge liability for Obama, again, not one of the presumably well-informed commentators thought it worth correcting. Though, in their defense, Kokie Roberts and Sam Donaldson were too busy telling George S. that the worst presidential debate of my politically-conscious lifetime in fact did focus on matters that were important to our democracy.

Anyway, am I wrong here, and, if not, is this actually getting any press?

[Bernard Yomtov]

am I wrong here,..

No. You are correct.

The respect accorded people like Will, Roberts, etc. is amazing to me. Just think about it. Whatever issue comes up, they are allowed to pontificate on it, to act like experts, to educate the masses. Doesn't matter if it's taxes, the economy, Iraq, European politics, the Israeli-Palestinian issue, China, constitutional law, on and on. How did they convince everyone that they know so much?

The fact is, whenever they talk about some topic where I am somewhat knowledgeable I find they often make elementary mistakes, as here. I'm sure others have similar experiences.

[Gromit]

What gets me is that this isn't exactly esoteric knowledge. There aren't two sides to the question. The tax code is clear, authoritative, and widely available. Any CPA or investment advisor could tell McCain he's full of it. So how does he get away with it?

This is a perfect opportunity to demonstrate just how ignorant or dishonest McCain is about matters of finance and how out of touch he is with the lives of working people, and it's just sailing by.

[felix culpa]

McCain Announces He Will Follow Christopher Ward’s Finance Methods (EmptyWheel) might pertain. Ward was the creative NRCC accounting guy.

About McCain’s games with campaign finance.

[Slartibartfast]

But maybe Dean Baker is being just a tiny bit unfair to McCain

A better criticism of McCain's idea of suspending federal taxes on gasoline can be found here, which at least cites actual previous experiments. Probably not as good as Baker's in-the-noggin simulation of things, but the results are about the same.

Still, Baker's assertion here is that the price of gasoline is fixed by demand. We can affirm that by experimentation, I say: we can double the gas tax. If Baker is right, the demand forcing will keep the price of gasoline right where it is, and Exxon will then be producing gas at a loss. Or, alternatively, Baker is dead wrong, and the price of gas will go up, because Exxon won't produce gas at a loss, and consumers will pay the extra amount to get any gas at all. Supply and demand, not or.

Similarly, one can remove the fuel tax, nationwide, for some indeterminate (but long) period, and see what price competition does to the price at the pump. I'd guess that what will happen is that eventually, over a period of weeks or months, the price will fall to the point where Exxon and its competition return to their current profitability.

Or, Baker could be right, and price competition would not occur, and oil company profitability will rise greatly. I don't think that'll happen, but I don't do economies for a living.

None of this is to support McCain's proposal, which is a gimmick IMO.

[Slartibartfast]

Shorter me: is Baker's point really that the only thing between oil companies and double-digit profitability is the federal gas tax?

[hilzoy]

Slarti: when Baker said supply was fixed, I took him to mean that it had an upper bound, not that it would continue to be as high as it is regardless. Also -- and here I'm drawing on a discussion I saw somewhere, but alas I can't remember where -- that he's talking short-term (b/c McCain's proposal is short-term -- Mem. Day through Labor Day of this year), and thus is not factoring in things like the possibility of building more refineries. (Which presumably no one would do in response to the demand created by a one-time, three-ish month suspension of the gas tax.)

The supply of oil, i think, moves sort of jerkily in response to demand: refinery capacity acts as a bottleneck if demand goes high enough, and while refinery capacity both reflects previous market conditions and can, given time, respond to new ones, it's not instantaneous.

[Bernard Yomtov]

Slarti,

Changing the tax deos not change consumer behavior at the pump. The gasoline buyer doesn't care how much of theprice is tax and how much goes to the oil company. Only the total price matters. So the change acts by shifting the supply curve.

I think the point is that in the short run the supply curve is vertical above a certain price, and zero below it. That is, refinery capacity limits how much supply can increase regardless of price increases. (Normally, removing a tax effectively shifts the supply curve out, lowering the consumer's price, while raising oil company revenue, but here the curve can't move.) The only other choice is not to produce at all, because it is a money-losing proposition.

Increasing the tax may push the price received by the company down so low that they choose not to produce at all. Either that or it will in fact cut into oil company profits. Why will they not compete on price if the tax is removed? Because there is nothing to be gained by doing so. If you are already selling all your capacity at the current price why cut it to gain more business?

[Slartibartfast]

If you are already selling all your capacity at the current price why cut it to gain more business?

I'd say that depends on who "you" is, and who is the recipient of the proceeds from the increased price. If the gas tax were charged at the pump (and I don't think this is currently the case) there'd be more price-competition, and the refineries would sell to whoever had the most need. Of course, there are bottlenecks at the point of sale, too, so this only carries so far.

But, overall, point taken.

Unrelated, I thought this was timely.

[LFC]

John McCain once again proved he is incapable of forming a reasonable position on the economy. Not only does he want to cut taxes even more, while insisting he can magically cut over half a trillion dollars from the budget, but he doesn’t even understand how the capital gains tax works.

http://www.youtube.com/watch?v=Q2uEc4iiNyM> Here he is On “This Week” (3:20-3:46) saying that a change to the capital gains tax will impact people with 401(k)’s. Hey, John. Most qualified retirement plans aren’t taxed at the capital gains rate, they’re taxed as income. This is Financial Planning 101. Maybe you should pick up a free booklet about retirement plans from Vanguard.

As to his comments (and others' on this board) about cutting capital gains brings in more tax revenue, there are two points which didn't get addressed:

1) To raise more taxes by doing this, the price of equities must rise. Basically, you're artificially inflating value by reducing taxes. As a result, average PE ratios go up and we have "more" ... with the same amount number of shares. It's a bubble, just like real estate. And it's not sustainable.

2) Please give me an example of when we had a capital gains tax without a big corresponding debt-fueled spending increase to stimulate the economy. Reagan? No way. His spending was WAY up. Bush I? Ditto. Bush II? Completely off the charts. In each of these cases, not only did we get the stimulus (and debt) associated with the tax cuts, but we increased spending above and beyond. Let me rack up a few trillion in debt and I'll make the economy look rosy too.

[Bernard Yomtov]

Actually, you could get a bump in 2008 revenue by raising CG taxes sharply effective 1/1/2009. You'd get a lot of selling in anticipation of the higher rate. Once 2008 ended you could defer the increase to 2010, to get lots of gains realized and taxed again in 2009. How long people would fall for the trick is unknown, but once they stop biting you could just let the increase remain in place.

Could be fun.