Wednesday, August 13, 2008

Obama's Tax Plan and Basic Honesty

UPDATE: Also see our more recent post on the candidates' tax plans.

Greg Mankiw links to this attack on Obama's tax plan by Alex Brill and Alan Viard of AEI. Mankiw's post provides only a graph titled "Effective Marginal Tax Rates: Obama v. Current Law", offering the link so that readers can "Click through to the read the thousand words". From what I can tell, the Brill-Viard piece, titled "The Folly of Obama’s Tax Plan", is one of those screeds meant to confuse rather than inform.

1. According to Brill and Viard, the chart Mankiw posts shows

"the marginal rates in 2009 for a two-earner couple with two children—a college freshman and a 12-year-old receiving after-school care—under some specific assumptions"
Now, when you see someone relying on a special case like a two-earner couple with two children, one of whom is a college freshman and the other is exactly 12 and receiving after-school care, you know there's cherry-picking going on. Here, Brill and Viard are clearly trying to maximize the impact of tax-credit phaseout rules on marginal tax rates. And they don't tell us what their "some specific assumptions" are. Judge for yourself whether it's fair to take this one special case and call it "Obama's Tax Plan".

2. Brill and Viard are very helpful to readers, asking and answering the question "What accounts for the higher rates?" (they mean the ones in their cherry-picked chart, specifically). Here's part of their explanation (emphasis added):
First, Obama expands the maximum child and dependent care credit for families with one young child from $1,050 to $1,500 and phases down the credit over a longer income range, from $30,000 to $58,000. Throughout this income range, the credit is phasing out at a rate of $30 per $1,000 of income, thus raising the effective tax rate by 3 percentage points. Obama also makes certain credits refundable, which introduces a tax penalty of 10 percent or 15 percent, depending on the income bracket.
To understand how deeply dishonest the Brill-Viard piece is, you need only recognize that each of these three examples is a case in which Obama's plan increases the after-tax-and-transfer income available to the people at issue. The rest of their explanation involves Obama's proposal to increase the maximum of the current Hope Scholarship Tax Credit for college from $1,800 to $4,000 while keeping the same phaseout range. Three comments:
  1. When a plan "expands" a credit's maximum, it is increasing the credit's generosity, not decreasing it.
  2. When a plan "phases down the credit over a longer income range", it is increasing the credit's generosity, not decreasing it.
  3. When a plan "makes certain credits refundable", it is increasing those credits' generosity, not decreasing it.
Marginal tax rates rise under Obama's plan in this cherry-picked example (assuming that Brill and Viard haven't cooked the numbers themselves) because credits have to be phased out at higher incomes, or else everyone will receive them, making them much more expensive. This is hardly a new concept, and Greg Mankiw surely understands it well. If he and the AEI distortion machine wanted to have an honest debate on Obama's tax plan, they could discuss its cost, or they could provide an honest argument over why they think the disincentive effects of higher marginal rates outweigh the benefits of increasing disposable income for lower and middle income folks.

Instead, their argument boils down to making a big deal about the fact that disincentive effects....exist! That sort of observation won't win you the Nobel prize.

The key point that Brill and Viard neglect to note or discuss is that even in their cherry picked example, higher marginal tax rates bring along offsetting benefits to families with lower and middle incomes. If the families don't change their behavior, their disposable income will be higher, not lower, under Obama's plan. If they do change their behavior, then by revealed preference, these families will still be better off, since every supposedly nefarious change in the tax code that Brill and Viard mention is an expansion in generosity. Revealed preference says that you can't be made worse off by having more options. This is a question of basic microeconomics.

It's also a question of basic honesty.

An honest article meant to inform would show both the marginal tax rates graph and a graph of after-tax-and-transfer income against pre-tax-and-transfer income. I assure you that there is a very good reason that Brill and Viard don't include that second graph. Of course, a really honest article wouldn't cherry pick the way Brill and Viard did, either.

NOTE (from Don Pedro): I make some similar points in a parallel post.

14 comments:

Steve Roth said...

The disingenuousness of the article is obvious from the moment you read the title of their graph: "Effective Marginal Tax Rates."

What does that *mean*? Why don't they just discuss effective tax rates at different income levels?

Maybe because the effective tax rates for middle-income people under Obama's plan will be lower?

Laser said...

"An honest article meant to inform would show both the marginal tax rates graph and a graph of after-tax-and-transfer income against pre-tax-and-transfer income. I assure you that there is a very good reason that Brill and Viard don't include that second graph. Of course, a really honest article wouldn't cherry pick the way Brill and Viard did, either."


I just came here from Marginal Revolution which linked the site.

And I'm having trouble understanding the quoted text above.

Laser said...
This comment has been removed by the author.
Laser said...

"An honest article meant to inform would show both the marginal tax rates graph and a graph of after-tax-and-transfer income against pre-tax-and-transfer income."

So the latter graph would simply look a little less dramatic.

But still, with this "cherry picked" example you'd still be better off with the old tax policies.

Laser said...

Apparently I misunderstood the concept of "marginal".

Admin said...

Nobody has mentioned the cut-off of the below $25K range, where there's a lot action in marginal effective rates that could be affected by Obama's proposals.

If I was at my old job I would produce such a graph. Somebody else should.

(Hi Jonah)

Miracle Max

Frop said...

My understanding is that "marginal tax rate" means how much your taxes change for each additional dollar in income. So a very steep percentage change in taxes may be a disincentive to work, which is what the graph appears to be implying. However here they are saying that even though the tax rate is rising, it is being offset even more so by other benefits, so it can't really be seen as a disincentive. Do I have this right?

Frop said...

My understanding is that "marginal tax rate" means how much your taxes change for each additional dollar in income. So a very steep percentage change in taxes may be a disincentive to work, which is what the graph appears to be implying. However here they are saying that even though the tax rate is rising, it is being offset even more so by other benefits, so it can't really be seen as a disincentive. Do I have this right?

Cobb said...

The proper answer would be presented in a chart. What's the net effect on the taxes I pay under Obama's plan by income. If it's so easy to discredit the analysis, shouldn't it also be easy to make a corrected chart?

Alan Viard said...

As one of the authors of the article being discussed, I want to respond to the unfounded accusations made here.

Gelbach's suggestion that we "cooked" the numbers is a vile libel for he which he presents no evidence. The accusation is utterly false.

Gelbach also says that it is "deeply dishonest" and a violation of "basic honesty" to say that Obama's plan would raise marginal tax rates as well as reducing tax payments. In fact, since Obama's plan would do both of those things, basic honesty requires that both effects be mentioned, as we do in our article. We repeatedly make clear that Obama would cut taxes for the poor and the middle class: the topic sentence at the beginning of the second paragraph states that "Obama is offering a new series of tax breaks," the next paragraph says that he would make some tax credits refundable (and illustrates refundability with an example which makes clear that it involves a reduction in tax payments), the fifth paragraph mentions that he would expand a tax credit and repeats that he would make credits refundable, and the seventh paragraph mentions that he would increase another credit's maximum value. Gelbach himself quotes some of these statements. It is unclear what aspect of Obama's tax plan we are supposed to have concealed, but it certainly can't be the fact that he's cutting taxes.

Yesterday, one blog (that apparently looked at the chart without the article) did trumpet our work as showing that Obama would impose "higher taxes" on nearly everyone; I immediately posted a comment explaining that Obama would lower tax payments.

The point our article makes is that Obama's tax cuts are designed in a way that increases disincentives by raising marginal rates and increases complexity. Since Gelbach himself admits that the disincentive effects exist (and explains why they arise), it is unclear why he considers this claim dishonest.

Of course, he's perfectly free to draw different policy conclusions from this fact; that's the kind of debate Alex and I hoped to encourage. So far, the disincentive effects have scarcely been mentioned, so pointing them out is a necessary step towards informed discussion.

The reason we graph effective marginal tax rates rather than average rates is because the former, not the latter, control incentives, which was the topic of our article. The fact that Obama's plan lowers average rates in this income range is clear from the text of our article (as explained above) and is abundantly documented elsewhere (see the excellent calculations by the Brookings-Urban Tax Policy Center study that we cite in our article). Steve Roth asks why we label our graph of effective marginal tax rates "Effective Marginal Tax Rates"; the answer, to coin a phrase, is basic honesty. Our label makes clear that we are not talking about, or claiming that Obama would raise, average tax rates.

I don't have space to defend the example, but it is not "cherry picked." Some other examples would show bigger disincentive effects; others would show smaller. Unfortunately, there is no typical example to fall back on, because different kinds of households are affected in so many different ways. But, since it's undisputed that Obama makes credits refundable and increases the use of phase-outs, any example will show these kinds of disincentive effects. Can any of our critics construct a remotely realistic example that doesn't? Again, Gelbach himself admits that the disincentive effects exist. (As a side note, the child in our example need not, of course, be exactly 12, but can be any age 12 or younger).

Alex Brill and I hoped that our article would call attention to the disincentives and complexity of Obama's tax cuts, an important topic neglected in the discussion to date. It is unfortunate that this discussion has been sidetracked by misinterpretations of the (clearly stated) points in our article.

Alan D. Viard, Resident Scholar
American Enterprise Institute

Don Pedro said...

Alan,
Thanks for taking the time to comment.

I'll let Jonah defend the general sense of his post.

But on what seems to be the most important point: it's clear you have cherry-picked the analysis, by taking a case of a household with children who are getting both the child care credit and the college tuition credit. This means (I think) that the high marginal rates you point to would be lower for a household with any other composition. I can't tell for sure because you don't provide the full set of information and assumptions you used for the analysis, as you would have if you had intended this to be an honest exploration of marginal rates under Obama's proposals.

yonran said...

That's actually a pretty cool graph, and the anger seems to stem from people trying to integrate without knowing the magnitude of the differing impulses at $0. For a college student's parents, marginal income is even lower due to financial aid (those formulas aren't open to study, as far as I know). But more importantly, people making under $40k probably are trying to earn as much as they can, because each additional dollar is worth so much more to them than to a richer person—so much so that a higher tax rate may not matter. Does anyone know what the labor elasticity of income is?

yonran said...

On second thought, it's not such a useful graph... it doesn't answer the question, "Would the poor be better off today or under Obama?" Instead, it begins to provide data for "Are the incentives for increasing GDP higher today or under Obama?" and one must then balance this answer with the social benefits of GDP vs. health or stability. Due to the low labor elasticity of demand for income under $40k, the higher marginal tax probably doesn't matter, but it does matter to the right where elasticity is higher but the graph cuts off. What I want to know is, if you take everything into account (taxes, foodstamps, financial aid, section 8 housing, SSI, subsidized utilities and phone), does the marginal net income ever go close enough to 0, or even below 0, so that poor people find a local maximum in net income and have a decide not to work? This graph doesn't go close to answering that.

glh said...

Sure marginal rates increase when credits are phased out, but the average rate is lower. Thus, the tax liability is lower. I don't think we have to worry very much about disincentives from the higher marginal rates in this case. I seriously doubt the father/mother of a college freshman and a 12 year old are going to cut back their hours of work as result. I bet they would appreciate the lower average rates.
But, just in case, they could avoid the higher marginal rates by simply not taking the credits.