Friday, August 15, 2008

More on the Obama Tax Plan, and the Effects of the McCain Deficits

TaxProf has a good roundup of commentary on Obama's tax plan media blitz yesterday. Along with the Goolsbee and Furman WSJ op-ed, the campaign released a new detailed tax plan, along with this summary, key facts, and comparison with the McCain tax plan.

Mostly this is just a repackaging of his plan in an easy-to-digest form, to rebut the completely bogus claims from McCain that Obama will raise taxes on the middle class. There are just a couple new specifics: the capital gains and dividend tax rates would be raised to 20% for those making over $250, and payroll taxes for those making over $250K would go up 2% to 4%.

The op-ed says

Sen. McCain has put forward the most fiscally reckless presidential platform in modern memory. The likely results of his Bush-plus policies are clear. As Berkeley economist Brad Delong has estimated, the McCain plan, as compared to the Obama plan, would lower annual incomes by $300 billion or more in real terms by 2017, costing the typical worker $1,800 or more due to the effect of large deficits on national savings and thus capital formation. Sen. McCain's neglect of critical public investments would further impede economic growth for decades to come.
Here is the analysis from Delong that they're referring to and some additional comments from Brad.

The analysis is plausible but frustrating, in the same way that macroeconomics is frustrating. Simply put, there's no coherent moden macroeconomic framework. So your options for analysis are simple IS-LM calculations, macroeconometric models like the Fair model--which have various limitations and are vulnerable to the Lucas critique, or ad hoc reasoning incorporating whatever points the researcher wants to highlight. Most (almost all?) published macro papers these days are in the ad hoc category, as is Delong's note. He considers three possible negative effects of McCain's extreme deficits, does a back-of-the-envelope calculations, and adds up their total cost per worker. The trouble is that Holtz-Eakin will no doubt come back and quibble with his assumptions, argue that that there are other effects, etc.

Part of the difficulty is that the deficits McCain's proposal would create are outside the boundaries of recent experience in the U.S. Nonetheless, I think almost every economist would agree that running such huge deficits would almost certainly have some severe consequences. For other countries, going so far into the red would generate a crisis of confidence and spur capital flight. Delong explicitly does not consider this effect:
Since 1981 the US has been lucky: inflows of capital from abroad have partly financed the growth of government debt. At some point, this will stop, and increases in deficits will trigger capital flight from the US. Suppose that over the next eight years larger deficits trigger neither extra capital inflows nor capital outflows.
He also doesn't try to quantify the danger that our lenders--largely the Chinese--might use our thirst for debt financing as geopolitical leverage. In whatever conflict that might come down the road, the threat to cut us off from our debt fix and thus spark an economic crisis in the U.S. could be a powerful weapon.

Given these immense costs that he doesn't evaluate, I think it's fair to say that Delong note gives a very conservative estimate of the dangers of McCain's deficit proposals.

NOTE: Jonah and I have developed the unfortunate habit of posting almost simultaneously on similar topics. If you haven't seen it, check out his post on the WSJ op-ed.

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