Archive for the 'Laffer Curve' Category

Sep 17 2010

Obama versus the supply-siders – to extend the Bush tax cuts or not? That is the question…

As the United States enters its mid-term election period, one of the major issues being discussed in Washington D.C. is whether or not the “Bush Tax Cuts” of 2001 and 2003 should be extended. In essence, the tax cuts under the previous president lowered America’s marginal tax rates at all income brackets. From the Wikipedia article on the “Bush tax cuts”:

  • a new 10% bracket was created for single filers with taxable income up to $6,000, joint filers up to $12,000, and heads of households up to $10,000.
  • the 15% bracket’s lower threshold was indexed to the new 10% bracket
  • the 28% bracket would be lowered to 25% by 2006.
  • the 31% bracket would be lowered to 28% by 2006
  • the 36% bracket would be lowered to 33% by 2006
  • the 39.6% bracket would be lowered to 35% by 2006

To be clear, the White House and president Obama do not want to repeal all of the tax cuts above, only those enjoyed by those in the highest income bracket. The 35% marginal tax rate only applies to households earning above $250,000 in the United States. This bracket includes less than 2% of American households. So what Obama wants to do is raise the marginal tax rate by 4% on income earned above and beyond $250,000. Only a couple of million Americans will be affected by this tax increase, while more than 98% of American households will experience no increase in income taxes.

The backlash against Obama has been fierce. The main argument against raising taxes on the richest Americans comes from the Republican party, who argue that higher taxes on the rich will decrease the incentive for workers to produce more output and increase productivity to earn higher incomes. In addition, say the Republicans, it is the rich who are the investors, the capitalists, the firm owners in an economy. Increasing income taxes on the rich will decrease their incentive to invest and thus decrease the overall demand for labor in the nation, leading to lower overall levels of employment and national output. This supply-side argument claims that higher taxes may in fact lead to less taxable income, thus lower tax revenues for the government.

The Economist’s Free Exchange Blog wrote a piece last year on supply-side economics and the Laffer Curve, a popular graphic used by the supply-side to argue against increases in taxes.

Laffer Curve

“The basic reasoning behind the so-called “Laffer curve” is plain, uncontroversial, and by no means was discovered by Arthur Laffer. There is nothing to tax if no one produces anything. But taxes affect the return and therefore the motive to supply labour to economic production. An increase in the tax rate can reduce the pool of wealth to tax — the tax base — by reducing the supply of labour. No taxes, no revenue. Also, 100 percent tax rates, no revenue. Somewhere in between — exactly where depends on, among other things, the responsiveness of labour supply to after-tax wages — there will be a point at which an increase in rates delivers a decrease in revenue. If the tax rate is already past that point, a tax cut delivers more revenue.

…labour supply is just one of many ways in which an increase in tax rates may reduce the effective tax base. In addition to working less, individuals may alter their savings and investment patterns, bargain to shift more of their labour compensation to untaxable perks and benefits, move to a different tax jurisdiction, consume more tax-deductible goods, or simply hide income from the tax authorities.”

As Laffer’s model shows, at certain tax rates, a tax cut will lead to an increase in tax revenue. So how can policy makers be sure whether the United States is currently at a point on its Laffer curve that an increase in taxes won’t result in a decrease in tax revenue?

“Supply-siders” who oppose Obama’s plan to repeal the tax cut, and even argue further tax cuts would benefit the US economy, need to look more carefully at where America is on the Laffer curve.

Republican politicians of late have exhibited a dismaying lack of respect for basic science, and it is not much of a surprise that many are also cavalier about fiscal economics. At current tax rates, new cuts will not “pay for themselves” in the short run. Emphasizing this point, however, does not begin to imply that raising tax rates is smart or harmless.

In a separate piece on the Economist’s blog, the relationship between tax rates and long-run economic growth is further analyzed.  The blog presents the main point of the supply-side argument:

Our baseline specification suggests that an exogenous tax increase of one percent of GDP lowers real GDP by roughly three percent.

On the other hand…

…we find that a tax cut of one percent of GDP increases real output by approximately three percent over the next three years.

So do tax cuts “pay for themselves” as some politicians in the United States have argued in opposition to Obama’s desire to let Bush’s tax cuts expire?

Tax cuts don’t exactly “pay for themselves”, but they also don’t diminish revenue after about two years. That is, after about two years, the government receives revenues equal to what it would have received at the higher rate, but taxpayers enjoy a lower burden. It is an important advance to discover that because cuts do lead to an immediate dip in revenue, they often inspire offsetting tax increases that retard the growth effect of the origina cut. Nevertheless, the effect of cuts on output is generally strong enough to bring revenue back to where it would have been otherwise.

So it’s possible that keeping taxes lower may indeed lead to higher growth and more taxable income down the road in the United States. But all the above analysis neglects to take into account one other VERY important consideration that the US government must consider at this point in time. In a year in which several European nations, most notably Greece, have encountered debt crises, the need to generate tax revenues to finance government spending is as important as ever.

Ironically, some of the same people who oppose ending the Bush tax cuts on the rich also oppose deficit financed fiscal stimulus. People like Niall Ferguson argue that continued deficits threaten to “bring down the US bond market” as foreign and domestic investors lose faith in the US government’s ability to pay off its ever growing national debt. These “deficit hawks” argue that the US should take drastic steps to balance its federal budget, much as several European governments have begun to do, to reduce the likelihood that investors will begin demand higher interest rates for investing in government bonds, which in turn could drive up interest rates for the private sector, crowding out private investment and plunging the US economy into another recession.

The tradeoff may come down to this. Higher taxes now, or higher interest rates AND higher taxes  in the future. Raising taxes on the rich now will allow the US to achieve a more balanced budget in the future. This means less government borrowing, less government debt, and lower interest rates on government bonds and in the private sector. It also means that there will be less debt to pay interest on, which makes debt repayment (currently almost 10% of the government’s non-discretionary budget),  less of a burden in the future. A more balanced budget now (achievable if we repeal the tax cuts for the riches Americans) means less debt in the future, lower taxes in the future, and lower interest rates in the future.

I’ve always said that humans are short-run creatures living in a long-run world. I think Americans epitomize this reality. American voters can always be convinced to vote against new taxes, or vote for the guy who promises to lower their taxes. But in this case, over 98% of Americans will not even be affected in the short-run, however in the long-run the majority stands to gain from tax increases on the rich in the form of less debt to be repaid and more private investment as government borrowing and the resulting crowding-out of interest sensitive spending by the private sector is reduced.

By the way, one of the most prominent supply-side economists of the last half century agrees with me on this one. Here’s former Chairman of the Federal Reserve Alan Greenspan arguing for a repeal of the Bush tax cuts:

Discussion questions:

  1. Under what circumstances would a tax increase harm not only workers and firms, but reduce government tax revenue as well?
  2. What would a Keynesian say about the wisdom of raising taxes at a time when unemployment is as high as it is in the United States right now?
  3. How does achieving a more balanced budget now assure that Americans will have to pay less in taxes in the future?
  4. Do you believe that asking the riches Americans to pay 4% more in marginal taxes now will lead to more unemployment in America? Why or why not?

32 responses so far

Sep 17 2010

Supply – side economists: “lower taxes, more growth, more tax revenue!”

This is a follow up to a recent post to this blog, Hey, what are you Laffing at? The relationship between tax rate and tax revenue

The unbearable lightness of being Martin Feldstein | Free exchange |

Supply-side economics, advocated by most Republican politicians, including presidential candidate John McCain, places great emphasis on the idea that investment is the main engine of economic growth, price level stability, and low unemployment. To encourage firms to invest, government should play a minimal role in the economy; taxes should be sufficiently low to incentivize firms to invest, while at the same time government spending should be reduced to avoid crowding-out of private investment.

Without a healthy level of investment, a country’s capital stock wears out and is not replaced, raising costs of production and shifting short-run (and maybe even long-run) aggregate supply leftward. If investment remains sufficiently low, over time an economy’s output could even begin to shrink.

In the article below, The Economist’s Free Exchange explores the relationship between tax rates and long-run economic growth. The Economist takes the position of “supply-siders” who study the impact of tax rates on the level of output. The idea of supply-side economics is that lower taxes encourage more investment and thus higher growth rates.

Here’s the gist of the supply-side argument:

Our baseline specification suggests that an exogenous tax increase of one percent of GDP lowers real GDP by roughly three percent.

On the other hand…

…we find that a tax cut of one percent of GDP increases real output by approximately three percent over the next three years.

In the case of the Laffer Curve, which shows the relationship between tax rates and tax revenue, the article concludes that:

Tax cuts don’t exactly “pay for themselves”, but they also don’t diminish revenue after about two years. That is, after about two years, the government receives revenues equal to what it would have received at the higher rate, but taxpayers enjoy a lower burden. It is an important advance to discover that because cuts do lead to an immediate dip in revenue, they often inspire offsetting tax increases that retard the growth effect of the origina cut. Nevertheless, the effect of cuts on output is generally strong enough to bring revenue back to where it would have been otherwise.

Supply-side economics, folks. Understanding the effects of fiscal and monetary policies on not only aggregate demand, but on aggregate supply (both short-run and long-run) is a crucial skill in  answering AP free response questions.

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19 responses so far

May 18 2010

The role of taxes in income re-distribution – another preview of my textbook

Inequality in the distribution of income is an inevitable result of an economic system that rewards the households with the highest skills, best education and most access to capital with higher wages and incomes in the marketplace.

The existence of poverty, both relative and absolute, poses several obstacles to the improvement of well-being for a nation’s people. Social unrest among the poorest members of society can lead to political and economic instability for a nation as a whole. The hardships experienced by society’s poorest members are ultimately felt by the rest of society as the needs of the poor must be met in one way or another, and in extreme circumstances may lead to a violent struggle between economic classes.

The existence of absolute poverty poses the greatest obstacle to national economies and society as those who experience it are unlikely to contribute whatsoever to national output and economic growth given the desperate state of their health and education. Without promoting some degree of equality in the distribution of income, governments run the risk of undermining their accomplishment of other social and economic objectives. So how do governments achieve more equal income distribution? Before we look at the modern mechanisms by which this objective is achieved, it is important to examine the historical ideology that frames modern economic policy.

For centuries the role of government has been debated among economists. The extent to which it is the government’s job to assure equality in the distribution of income has never been fully agreed upon by policymakers, whose opinions differ depending on the school of economic ideology to which they prescribe. On the far left of the economic spectrum is Marxist/socialist ideology, which believes that households’ money incomes should be made obsolete and each household’s level of consumption should instead be based on the “use-value” of the output which it produces. In a pure Marxist or socialist economy, money incomes do not matter since the output of the nation will be shared equally among all those who contribute to its production. Private ownership of resources and the output those resources produce is wholly abolished in a socialist economy and the ownership and allocation of resources, goods and services is in the hands of the state and production and consumption is undertaken based on the principle of equality.

The slogan “from each according to his ability, to each according to his need”, made populate by Karl Marx, summarized the view that a household’s consumption should be based on its level of need. To take this idea to its logical conclusion, all households in a nation have essentially the same basic needs therefore household incomes should be equal across the nation.

On the other extreme of the economic spectrum is the laissez faire, free market model which argues that the only role the government should play in the market economy is in the protection of private property rights, which assures that the private owners of resources, including land, labor and capital, are able to pursue their own self-interest in an unregulated marketplace where their money incomes are determined by the “exchange-value” of the resources they control. In a laissez-faire market economy, the level of income and consumption of households varies greatly across society as the exchange-value of the resources owned by households determines income, rather than the principle of equality underlying socialism. Each individual in society is free to pursue his monetary objectives through the improvement of his human capital and the subsequent increase in its exchange-value in the labor market.

In today’s world, there exists neither a purely socialist economy nor a purely laissez fair free market economy. In reality, all modern national economies are mixed economies in which governments do much more than simply protect property rights, but do not go so far as to own and allocate all factors of production. The role of government in the distribution of income in today’s economies is relegated to the collection of taxes and the provision of public goods and services and transfer payments.

A tax is simply a fee charged by a government on a person’s income, property, or consumption of goods and services. Taxes can be broken into two main categories: direct and indirect.
  • Direct taxes: These are taxes paid directly to the government by those on whom they are imposed. An income tax is a direct tax because it is taken directly out of a worker’s earned income. Corporate and business taxes are also direct taxes based on the revenues or profits of firms. Direct taxes cannot be legally avoided since they are based on the earned income of each individual. The burden of direct taxes is born entirely by the households or firms paying them.
  • Indirect taxes: These are the taxes paid by households through an intermediary such as a retail store. The consumer pays the tax at the time of his purchase of a good or service and the amount of the tax is usually calculated by adding a percentage rate to the price of the item being purchased. Indirect taxes include sales taxes, value added taxes (VAT), goods and services tax (GST) as well as ad valorem taxes (or excise taxes) which are placed on specific goods such as cigarettes, alcohol or petrol. Indirect taxes can be avoided simply by not consuming certain products or by consuming less of all products. The burden of indirect taxes is born by both households and firms, the proportion born by each is determined by the price elasticities of demand and supply (as demonstrated in chapter 4).

Taxes can be either progressive, regressive or proportional in nature, meaning that different taxes place different burdens on the rich and the poor.

Proportional tax: A tax for which the percentage of income taxed remains constant as income increases is a proportional tax. The rich will pay more tax than the poor in absolute terms, but the burden of the tax will be no greater on the rich than it is on the poor. A household earning 20,000 euros may pay 10% tax to the government, totaling 2,000 euros. A rich household in the same country pays 10% on its income of 200,000 euros, totaling 20,000 euros in taxes, but the burden is the same on the rich household as it is on the poor household. Proportional taxes are uncommon in advanced economies, although some “payroll taxes”, which are those collected to support social security or welfare programs, are payed by employers based on a percentage of employees’ incomes up to a certain level. For instance, the US social security tax is 6.2% of gross income up to $108,000. Regardless of a person’s income below $108,000, he or she will pay 6.2% to the government to support the country’s social security program.

Regressive taxA tax that decreases in percentage as income increases is said to be regressive. Such a tax places a larger burden on lower income households than it does higher income earners since a greater percentage of a poor household’s income is used to pay the tax than a rich household’s. You may be wondering what kind of government would levy a tax that harms the poor more than it does the rich, but in fact almost every national government uses regressive taxes to raise a significant portion of its tax revenues. Most indirect taxes are actually regressive, which may not make sense at first, since a sales tax is a percentage of the price of products consumed consumed. The regressiveness is apparent when the amount of the tax is compared to the income of the consumer, however.

To demonstrate how a sales tax is regressive, imagine three different consumers who purchase an identical laptop computer for 1,000€ in a country with a value added tax of 10% added to the price of the computer.
Income of buyer Amount of tax paid % of income taxed
10,000€ 100€ 1%
50,000€ 100€ 0.2%
100,000€ 100€ 0.1%

The higher income consumer pays the same amount of tax as the lower income consumer, but the the tax makes up a lower percentage of her income than it did the lower income consumer’s. Although they appear to be fair since everyone pays the same percentage of the price of the the goods they consume, indirect taxes such as VAT, GST and sales taxes are in fact regressive taxes, placing a larger burden on those whose ability to pay is lower and a smaller burden on the higher income earners whose ability to pay is greater.

Progressive tax: This is a tax for which the percentage of income taxed increases as income increases. The principle underlying a progressive tax is that those with the ability to pay the most tax (the rich) should bear a larger burden of the nation’s total tax receipts than those whose ability to pay is less. Lower income households not only pay less tax, but they pay a smaller percentage of their income in tax as well. Most nation’s income tax systems are progressive, the most progressive being those in the Northern European countries which, not surprisingly, also demonstrate the most equal distributions of income. Of the various types of taxes, a progressive income tax aligns most with the macroeconomic objective of increased income equality.

A progressive income tax typically consists of a marginal tax bracket in which the increasing tax rates apply to marginal income, rather than to total income. In such a system, the average tax a household pays increases less rapidly than the marginal tax, since the higher marginal rate only applies to additional income beyond the upper range of the previous bracket.

Income range Marginal tax rate
Tax paid by someone
at top of bracket
Average tax rate
$0-$8,375 10%
$8,375-$34,000 15%
$34,000-$82,400 25%
$82,400-$171,850 28%
$171,850-$373,650 33%
$373,850 -$500,000
(and above)
(on $500,000)

Notice in the table above that the total tax paid by Americans at the top of each income bracket is NOT the simply the tax rate times income. Rather, the tax rate for each income bracket only applies to income earned above and beyond the upper boundary of the previous bracket. An American worker earning $8,000, for instance, will pay $800 in income tax. But if his income increases to $10,000 he will NOT pay 15% of the full $10,000, or $1,500. Rather, he will pay 15% on the income earned above $8,375. Such a worker would therefore pay 10% of his first $8,375 ($837.50) plus 15% on the additional $1,625 he earned, which is another $243.75. The marginal rate of taxation (MRT) is the change in tax (t) divided by the change in gross income (yg). His total tax would therefore equal $1,081.25.

The marginal rate of taxation between the first and second income brackets above is found using the equation:

The average rate of taxation (ART) is equal to the tax paid (t) divided by the gross income (yg):

The average rate for workers who fall in the second income bracket above can be found using the equation:

For workers in each of the income brackets above, the average rate of taxation is always lower than the marginal rate of taxation, since tax increases only apply to additional income earned beyond the previous bracket. The graph below shows the marginal (in blue) and the average (in red) rates of taxation for individuals earning between $0 and $500,000 in the United States in 2010.

Marginal and average tax rates in the US

The main argument against progressive income taxes is that taxing higher incomes at higher rates creates a disincentive to work, in effect punishing any increase in productivity or effort among the nation’s workers. However, the fact that higher rates only apply to marginal income, rather than total income, assures that a worker’s after tax income will always be an increasing function of gross income; therefore there will always be an incentive to increase income by working harder, longer, or more efficiently since the increase in taxes will always be less than the increase income.

A progressive income tax system provides governments with an effective means of re-distributing the nation’s income since those with the greatest ability to pay (the rich) provide the nation with far more of its tax revenue than those with the least ability to pay (the poor). The graph below shows the total amount of tax revenue generated by each of the five quintiles of income earners in the United States in 2006. While the lowest 20% of income earners accounted for around 1% of total tax receipts, the top quintile contributed nearly 70% to America’s tax revenues.

Progressive income tax burden:data source:

In other Western economies, progressive income taxes typically account for the largest proportion of total tax receipts by the government. America’s neighbor to the north, Canada, has an even higher top marginal tax rate than the US, and rather than applying to people earning above $370,000, as it does in the US, Canada’s top tax rate kicks in for workers earning just $100,000 per year. In Canada, personal income taxes account account for around 50% of total federal tax revenues, while the corporate tax and the national goods and services tax make up the next largest portions.

As mentioned, the highest marginal tax rates tend to exist in the social democratic nations of Northern and Western Europe. Denmark, a country with a Gini index of 29, has the highest tax rate on top income earners. More significant than the high rate, however, is the fact that it kicks in at such a low income level, around $50,000 per year. This means that a large number of Danish workers are paying a high marginal and average tax rate. The burden of the income tax in Denmark is born not by only the rich, but by the middle class as well. In contrast, Germany’s top marginal tax rate of 47% is only reached when a worker’s gross income exceeds $300,000 per year, meaning the income tax burden in Germany will be born more by the rich than those earning lower incomes, as is the case in the United States.

Marginal tax rates in OECD countries,3343,en_2649_34533_1942460_1_1_1_1,00.html#pir

Arguments against progressive income taxes – the Laffer Curve:

The primary argument against the use of progressive income taxes as a means to redistribute national income comes from the “supply-side” school of macroeconomic thought. Supply-siders, whose views are formed by the classical theory of macroeconomics based on the belief that a free market economy left entirely to its own devices will always gravitate towards a level of production corresponding with full employment of the nation’s resources, believe there is a certain level of taxation at which a nation’s total tax receipts will be maximized. Beyond this point, further increases in the tax rat actually lead to a decline in the amount of taxable income due to the disincentive created by the higher tax rate. The Laffer Curve demonstrates the relationship between tax rate and tax revenue graphically:

At a tax rate of 0% households and firms will keep 100% of their gross income and there will be no tax revenue for the government. At a tax rate of 100%, however, there will also be no tax revenue since no rational individual will choose to work if the government takes everything he or she earns. The supply of labor falls as the tax rate increases since fewer individuals will be willing to work as the government collects higher percentages of their earned income. Therefore there will be no income for the government to tax when the tax rate is 100%.

Since both 0% tax and 100% create zero tax revenue, the Laffer Curve theory holds that at some tax rate (m) in between 0% and 100% the government’s total tax receipts will be maximized.The Laffer Curve is often cited by supply-side advocates as an argument for reducing marginal income tax rates on the top income earners. If, for instance, the tax rate is at y, it is possible that a lower tax rate could lead to higher tax revenue if the falling taxes incentivize individuals to join the labor force and existing workers to work harder and longer hours, creating more taxable income. In addition, entrepreneurs may be more inclined to start businesses and firms to increase their investments in physical and human capital, both activities contributing further to increases in national output and taxable income. At lower tax rates, argue the supply-siders, the level of taxable income may increase leading to higher tax revenues for the government.

It is not clear from the Laffer Curve at what precise level of taxation tax revenues are maximized. The model is most commonly employed by supply-siders to justify their desire for lower income and corporate taxes and a general reduction in the interference of the government in the functioning of the free market. The supply-side argument holds that lower taxes lead to an increase in the supply of labor and capital as households and firms are incentivized to become more economically active, leading to increases in the nation’s aggregate supply and thereby promoting the accomplishment of the macroeconomic goals of full employment and economic growth.

Practice calculating marginal and average rates of taxation in France (2010)

Marginal Income Brackets Marginal rate of taxation Worker’s gross income Tax paid Average rate of taxation
0-€5,875 0% €5,000
€5,876 – €11,720 5.5% €10,000
€11,721 – €26,030 14% €20,000 €1,480.675 7.4%
€26,031 – €69,783 €50,000 19%
€69,783 and above 40% €100,000 €27,537.575
  1. Calculate the total amount of tax paid by a French worker earning €10,000 per year.
  2. Calculate the average rate of taxation the same worker pays. Which is greater, the marginal rate of taxation or the average rate of taxation? Explain.
  3. What will a French worker earning €50,000 pay in taxes?
  4. Calculate the marginal rate of taxation for for a worker whose income increases from €20,000 to €50,000.
  5. What is the average rate of taxation for a French worker earning €100,000 per year?
  6. Evaluate the claim that a progressive income tax decreases the incentive among workers to work harder improve their productivity.

7 responses so far

Apr 16 2008

SAS student Alice Su critiques John McCain’s tax plan

Shanghai American School Economics Student Blog » You Hate Taxes, I Hate Taxes… Let’s Hug- by Alice Su

I’m repeatedly amazed at the intelligence and maturity of the young economists here at Shanghai American School. After only nine months of econ instruction, these students already know more about sound economic policy than politicians of 40 years! Case in point: SAS senior Alice Su offers an stinging critique of John McCain’s proposed tax plan over at the SAS Economists Blog. Read below…

It’s easy to see how politics and sound economic policy may not mix very well; in fact, trying to put the two together usually ends up in contradiction and confusion that puts economically concerned voters in great distress. (Example: Remember that one econ class when Welker was talking about taxes, trying to decide if he was more liberal or conservative, and then got so agitated that Jeff said “You’re having a midlife crisis” and Welker threw a smartboard marker at him yelling “I’M 29!!”? Case in point. :P)

In this case, McCain’s speech about his economic policies on Tuesday contains so many contradictions, both with classroom economic theory and various parts of his own policy platform, that I find myself questioning whether he is taking a solid stance on the economy at all, or is simply trying to say whatever will appeal to his audience the most.

First, McCain’s economic plan, dripping with supply-side sentiment, is centered around a series of tax cuts. In addition to making Bush’s tax cuts permanent, he also calls for cutting corporate taxes, phasing out the alternative minimum tax, doubling the value of exemptions for each dependent to $7,000 from $3,500, and giving people the option of using a simpler, shorter tax form. As a finishing tax-cut touch,

One of Mr. McCain’s tax proposals would take effect even before the Republican Convention: he called on Congress to suspend the 18.4 cent a gallon federal gas tax from Memorial Day until Labor Day. Mr. McCain said that doing so would provide “an immediate economic stimulus,” but some environmentalists said that the change might encourage more people to use their cars, while Mr. McCain has made combating global warming central to his campaign.

Hmm. Here’s where the first hints of contradiction kick in. Besides the conflict between wanting to end global warming and yet encouraging more cars on the road, we’ve all studied the Laffer Curve, and I think I can speak for all the SAS Economists when I say that the U.S. Economy is not at a place where further tax cuts will lead to an increase in tax revenue or benefit the economy. Furthermore, what about the enormous budget deficit that Mr. Bush has so graciously left us with? As the author of this article discreetly points out, McCain seems to have forgotten that he previously promised to balance the budget by the end of the first term; rather than offer the economic stimulus that McCain is claiming it will, the tax cuts would probably just plunge the nation deeper into debt.

What answers do McCain’s economic policy have to offer these questions? Well, he also proposes a one-year freeze on most “increases in discretionary spending” while he reviews every federal program, department, and agency… with the exception of spending on the military. Supposedly, the money saved from eliminating earmarks as well as getting rid of unnecessary “discretionary spending” will add up to $100 billion annually, and that is how McCain says he will pay for the lowered business taxes. However, he neglected to address the issue of all the money being spent on the wars in Iraq and Afghanistan, and whether any of that might be categorized as unnecessary “discretionary spending”, or whether we should be spending anything over there in the first place.

An analysis by the Center for American Progress Action Fund, a liberal think tank, estimated that the overall cost of Mr. McCain’s tax cuts would be three times as much as the $100 billion he estimates that he can save. And they questioned whether his programs would really save $100 billion a year.

While I’m not saying anything in support of Obama or Clinton’s economic policies, McCain’s plan seems so shaky that I would think twice before buying into how he’s going to save our country. Personally- especially since this tax-cut-focused speech was given on the day of the deadline for filing taxes- it looks to me like another plan designed for the purpose of politics, and not with sound economic policy in mind.

6 responses so far

Apr 03 2008

Obama – probably not a “supply-sider”

Wednesday’s class this week was one of my favorite of the year. Why? We got to talk taxes. Oh my goodness, you say, what’s wrong with Welker? How could he actually enjoy talking about taxes? As I said at the beginning of class, there are only two certainties in life: death and taxes.

For most people, taxes are a dismal subject, to say the least. But for teachers of economics, especially in this presidential election year, taxes make for an exciting economic, political and philosophical debate.

The premise of our discussion in class was the idea put forth by Arthur Laffer nearly 30 years ago towards the beginning of the Regan administration: that if the government would cut taxes on businesses and households, the incentive to invest and work would increase so much that gains in total output and income would be such that the government’s tax revenue might actually increase, despite the tax cut! Cutting taxes on the wealthy would have the greatest positive effect, however, since it’s the wealthy who do most of the investing and much of the spending in the economy.

This basic philosophy underpinned the tax cuts the wealthy enjoyed during Regan’s presidency, and again during George W. Bush’s term in 2001 and 2003. The debate about whether taxes cuts made by the current president is one at the heart of the Democratic/Republican divide today.

Watch the videos below, then answer the questions that follow:

First, the Democratic view:

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Then the Republican view:

[youtube rHMNl_P1-UQ]

Discussion questions:

  1. Why do Obama and Clinton promise that if they’re elected we’ll “go back to the tax rates we had before President Bush”?
  2. What is McCain’s criticism of Obama’s view on taxes?
  3. What do you think about the “supply-side” argument that lower taxes will stimulate spending, growth, employment, and possibly even the amount of tax revenue collected by the government? Do you buy it?
  4. Are you a “supply-sider” or more of a Keynesian when it comes to the role of government in the economy? What’s the difference?

4 responses so far

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