WISHFUL AND DANGEROUS THINKING

March 16, 2009

President Obama faces a dilemma: to pay for his plans and get the deficit down to manageable levels, he would return top tax rates to where they were before the Bush tax cuts, extract more from the rich by capping their deductions, increase taxes on corporations and auction carbon-emission permits.  At the same time, he promises permanent tax cuts for 95 percent of workers.  President Obama's plan begins to fall apart under economic analysis, says the Economist.

President Obama's budget forecasts that the economy will shrink 1.2 percent this year then grow by an average of 4 percent over the following four years.  These predictions may be exaggerated, explains the Economist:

  • The unprecedented damage to household balance sheets during the economic recession could well result in anemic economic growth for years, significantly undermining the president's revenue projections.
  • President Obama may either have to renege on his promise to slash the deficit to 3 percent of gross domestic product (GDP) in 2013 from more than 12 percent now, or rein in his spending promises or raise taxes more.

President Obama's scattershot tax increases are a poor substitute for the wholesale reform America's Byzantine tax code needs, says the Economist:

  • Limiting high earners' deductions for mortgage interest, local-government taxes and other things is certainly more efficient than raising their marginal tax rates even more, but it would be better to replace such deductions for everyone with targeted credits, abolish the alternative minimum tax, and implement a broad sales tax.
  • President Obama could simultaneously raise more revenue and make the tax code simpler and more conducive to growth; he is only asking the richest 2 percent of Americans to pay more taxes, building his change on shaky foundation.
  • Bush's tax cuts raised the proportion of American families that pay no federal income tax (or are net recipients of tax credits) from 33 percent to 38 percent; President Obama's will raise it to 44 percent, according to the Tax Policy Center, a research group.

Although many of these people pay payroll taxes, President Obama is also intent on reducing the link between payroll taxes and the pension and health-care benefits they were supposedly designed to pay for.  It certainly makes sense to keep poor people off the income-tax rolls, but removing a sizeable chunk of the middle class weakens the political bond between taxpayer and government, and will lead to pressure for more such spending, says the Economist.

Source: Editorial, "Wishful and Dangerous Thinking," The Economist, March 7th, 2009.

For text:

http://www.economist.com/opinion/displayStory.cfm?STORY_ID=13237211

 

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