The Public Policy

Obama’s New Tax Welfare

The Democrat will not only raise all taxes, but claim tax credits are tax cuts -- even though taxpayers will pay for these gifts to those who do not pay taxes.

By 8.27.08

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In 1984, Walter Mondale ran for President promising to raise taxes if elected. He consequently made it to the dustbin of history even before the Soviets, averting a 50 state shutout by just 1,200 votes in his home state of Minnesota.

The recently released details of Barack Obama's tax plan, published on his campaign website, along with an article by his top economic advisers in the Wall Street Journal, confirm that Obama makes Mondale look like a moderate. For Obama pledges not just to raise taxes. He proposes to raise every major federal tax. The recently released details confirm that:

* Obama would raise individual income taxes, increasing the top two income tax rates, with the top rate climbing by 13%, to almost 40%. This tax increase particularly hits small business, which creates the most new jobs in America.

* Obama would raise the top capital gains tax rate by 33%, to 20%.

* He would also raise the top dividends tax rate by 33%, to 20% as well.

* He would raise Social Security payroll taxes by 16% to 32% for families earning over $250,000 a year. He would consequently arbitrarily punish these families with an effective real return from Social Security of less than 0%, while making only a minor dent in the long term Social Security deficit.

* Obama would reinstate the death tax (estate tax) now being phased out under current law, with a top tax rate of 45%.

* The Obama health plan includes a new payroll tax on employers to pay for health insurance.

* Obama would impose several specified tax increases on corporations, including a new so-called windfall profits tax on oil companies.

* Obama's protectionist trade policies would mean higher taxes and tariffs on trade.

* Obama tries to argue, crassly, that these tax increases would fall only on "the rich." The tax increasers always start by saying that. But they always end up reaching down towards the middle class because that is where the big money is. The federal income tax was adopted almost 100 years ago with the promise it would only tax "the rich."

Moreover, the answer to Rick Warren's question as to who the rich are is small business employers who create most of the jobs, and investors who finance the jobs. Raising taxes on them ends up hurting the middle class and working people the most in terms of lost jobs, lower wages, and a weaker economy, discussed further below.

OBAMA TRIES TO HIDE these comprehensive tax increases with a slew of refundable tax credits he calls middle class tax cuts. The term "refundable" means that if the worker does not have enough tax liability to take advantage of the credit, the government sends the worker a check to cover the full amount of the credit anyway. So if the tax credit is for $1,000, but the taxpayer would otherwise only pay $200 in taxes, the credit covers the $200 tax bill and the government sends the taxpayer a check for the remaining $800. If the taxpayer pays nothing in federal income taxes, the government would send him a check for the whole $1,000.

The big trick behind the Obama tax plan is that his refundable tax credits would primarily go precisely to those who pay little or nothing in federal income taxes. The latest CBO data shows the bottom 40% of income earners already pay no federal income taxes. Indeed, they receive a net payment from the federal income tax system, meaning from the taxpayers, equal to 3.8% of all federal income taxes, because of the refundable tax credits under current law. The middle 20% of income earners, the true middle class, pays 4.4% of federal income taxes. Overall, the bottom 60% of income earners pay less than 1% of federal income taxes on net.

When "tax credits" primarily go to this group in the form of checks from the government rather than a reduction in their tax burden, such tax credits are not tax cuts. They are government spending programs hidden in the tax code. I call it The New Tax Welfare. Here is a complete litany of Obama's proposed new spending programs disguised as tax cuts:

* The fully refundable Making Work Pay Tax Credit would pay $500 to each worker and $1,000 to couples. This is reminiscent of George McGovern's 1972 election proposal for the government to send a $1,000 check to everyone.

* The Mortgage Interest Tax Credit would provide a 10% refundable credit to offset mortgage interest payments for lower and middle income families.

* The American Opportunity Tax Credit would provide a $4,000 fully refundable tax credit for the first $4,000 of college tuition expenses.

* The Obama campaign says, regarding Health Care Tax Credits, "Obama's health plan centers around tax credits that...will ensure that health insurance is available and affordable for all families." These include "a new refundable 50 percent health tax credit on employee premiums paid by employers."

* The Savers Credit would be made fully refundable and would be expanded "to match 50% of the first $1,000 of savings for families that earn under $75,000."

* The Child and Dependent Care Tax Credit would be made refundable and expanded to allow "low-income families to receive up to a 50 percent credit on the first $6,000 of child care expenses."

* The already refundable Earned Income Tax Credit would be expanded to "increase the number of working parents eligible for EITC benefits, increase the benefits available to noncustodial parents who fulfill their child support obligations, increase benefits for families with three or more children, and reduce the EITC marriage penalty, which hurts low-income families." This, of course, is a welfare program, not a tax cut, because it doesn't reduce anybody's taxes, it pays money to low income tax filers.

* The Tax Credits for Clean Vehicles includes a $7,000 tax credit "for the purchase of advanced technology vehicles." Presumably, this would be refundable as well because surely Obama would not deny it to the great majority of families.

Overall, this Obama tax plan is the opposite of tax reform. Tax reform involves lowering tax rates and closing loopholes. But the Obama plan raises rates and creates new loopholes.

The Obama plan is also the exact opposite of supply-side economics, which was so successful in creating the economic boom of the 1980s. Supply-side economics is based on lowering marginal tax rates, which strengthens incentives for investment, saving, entrepreneurship, business expansion, and work. But the Obama plan is based on increasing marginal tax rates for every federal tax, and so it would have the opposite effect, creating powerful disincentives to productive economic activity.

THE CENTRAL ISSUE in this campaign is whose economic policies would be best for our currently weak economy. Can we really believe that raising marginal tax rates across the board for every federal tax will be good for the economy? Even liberal Keynesian economics doesn't support that neo-socialist policy.

In a globalized economy, these policies would slam the American economy with even bigger competitive disadvantages. The result would be less savings and investment for America, with more funds shifting to investment in other countries instead. Business would decline rather than expand. All this would mean less jobs and lower wages. The shift in investment away from America would only accelerate the decline in the dollar, quite possibly maturing in outright capital flight out of the country. The high energy prices that Obama would perpetuate and even increase further with his anti-energy production policies would also be bad for the U.S. economy. All of this is a perfect prescription for a deep recession.

By contrast, McCain's tax proposals seem to target the exact problem areas for the American economy. America now suffers the second highest corporate tax rates in the industrialized world, averaging 40% with state income taxes. Since 1996, even the European Union has reduced its corporate tax rates from an average of 38% to 24% today. India and China also have lower rates. McCain consequently quite rightly proposes to reduce corporate tax rates from 35% to 25%, restoring American international competitiveness. Surely that is a far more promising approach for the economy than Obama's retro tax rate increases.

McCain also proposes an important tax cut on investment through immediate expensing, which means that capital costs could be deducted in the year they are incurred, like all other business expenses, rather than spread over many years under arbitrary depreciation schedules. Making the Bush tax cuts permanent, as McCain has pledged, would leave the top individual income tax rate at 35%, and the capital gains and dividends tax rates at 15%, while eliminating the repetitive death tax. He has also pledged to abolish the Alternative Minimum Tax (AMT) and keep the Internet tax free.

These policies would spur investment, not only domestically but from international sources as well. This would shore up the dollar, leaving the Fed more room to boost the economy. New and existing businesses would surge and expand hiring, producing more jobs and higher wages.

On federal spending also, McCain's proposed policies would be far better for the economy than Obama's. Obama is proposing vast new increases in spending, estimated by budget watchdog groups to cost well over a trillion dollars during his Presidential term, including even new entitlements like national health insurance.

McCain proposes a one-year freeze on all federal discretionary spending outside of defense and veterans benefits, and to limit overall federal spending growth to 2.4%, about one-third the annual increases since 2000. He promises to reclaim the money committed to earmarks, eliminate broken, ineffective government programs, reform procurement policies to cut wasteful defense spending, and "veto every pork-laden spending bill and make their authors famous." Through these policies, he proposes to balance the budget, not years into the future, but during his first term.

The Obama campaign has argued that their proposed overall tax plan is actually a net tax cut. But that is calculated by subtracting the actual spending on the numerous refundable tax credits from the actual tax burden imposed by the tax rate increases. Real taxes, and the highly damaging marginal tax rates, are unambiguously increased under the Obama tax plan.

The Obama campaign has also argued that their overall tax plan would leave federal taxes at only 18.2% of GDP. But this again is calculated by subtracting actual spending increases from the actual tax increases. Moreover, taxes at 18.2% of GDP would not be enough even to finance current federal spending, which is at 20.5% of GDP this year, or even more when the final numbers come in. How would Obama finance the additional trillion dollars in spending he is proposing? Such money is only going to be raised by, in fact, socking it to the middle class. Obama's tax plan is more worthy of a card shark, or an alchemist, than a Presidential candidate.

REPUBLICANS AND CONSERVATIVES should be trumpeting the fact that the results of Reaganomics over the past 30 years has been to abolish federal income taxes on the poor and the working class, and almost abolish them on the middle class. They should be emphasizing as well that another result of those tax policies is that the top 1% of income earners now pay 40% of all federal income taxes, and the top 10% now pay 71%, contrary to the foolish political propaganda of the neo-socialist class warriors. When Obama spouts that the rich need to pay their fair share, he should be asked what the heck is their fair share? 100%? 150%?

With the middle 20% of income earners now paying only 4.4% of federal income taxes, Republicans and conservatives should advocate just eliminating that tax on them, and take the credit for abolishing federal income taxes entirely for the middle class as well. That can best be done by lowering the current 25% federal income tax rate on those making $32,000 to $78,000, maybe all the way to 15%, which would lower taxes on the upper middle class as well. This would also restore wage growth for the middle class.

But the ultimate middle class tax cut is personal accounts for Social Security, which McCain also favors, but Obama does not. Personal accounts begin to replace the payroll tax, which is now the highest tax most taxpayers pay, with an engine for real, accumulated, personal family wealth. Over the long term, these personal accounts can and should replace the entire payroll tax, leaving middle income families to accumulate close to a million dollars over their lifetimes. Now that is a real, exciting, long term vision for the middle class.

But the neo-socialists don't want that, because that would liberate the workers from dependency on the Left's political machine. Their hot idea instead is to raise payroll taxes on the rich. Braindead. Can we just grow up, out of the cutting edge intellectual fads of the late 19th century?

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About the Author
Peter Ferrara is Director of Entitlement and Budget Policy at the Heartland Institute, General Counsel of the American Civil Rights Union, Senior Fellow at the National Center for Policy Analysis, and Senior Policy Advisor on Entitlements and Budget Policy at the National Tax Limitation Foundation. He served in the White House Office of Policy Development under President Reagan, and as Associate Deputy Attorney General of the United States under President George H.W. Bush.