What a (Tax) Relief

What a Relief
New York Sun Editorial
May 29, 2008

The Treasury Department marked the fifth anniversary of President Bush's signing into law the Jobs and Growth Tax Relief Reconciliation Act of 2003 by releasing two papers analyzing the effects of that and other tax cuts, and for those of us who enjoy the fine points of tax policy, they make for some fascinating reading.

We confess we stumbled a few times in making our way through the language, which seems at times to buy into left-wing assumptions. "Capital gains income, which is not captured in GDP, more than quadrupled between 1994 and 2000," says one of the papers. "Tax receipts from capital gains realizations more than tripled during this period, even though the tax rate on capital gains was reduced beginning in 1997."

Charlie Gibson, call your office. "Even though"? The tax receipts from capital gains didn't rise "even though" the capital gains tax was reduced, they rose because the capital gains tax was reduced. As the Laffer Curve graphically depicts, there is a point at which if you tax something less, you get more of it, and if you tax something more, you get less of it.

The paper makes the same rhetorical error later on, saying, "After 2004, tax revenues again grew faster than the economy. Despite the tax relief enacted earlier in the decade, the ratio of receipts to GDP was 18.8 percent in 2007, above the 40 year average."

"Despite" is the wrong word. Tax revenues did not rise "despite" the rate cuts; they rose because of the tax cuts. If we seem to be repeating ourselves, it's because it's almost impossible to overemphasize this point. It's a key to sensible tax policy. Rate reductions do not necessarily mean losses in government revenue. A portion of the revenue losses that would be predicted by a static analysis, sometimes all of them, sometimes more than all of them, are made up for by the effect of the rate cuts in spurring economic growth, work, savings, and investment.

Lest we seem too critical of the Treasury, let us say there is plenty of useful data in the papers. One point underscored is how the richest Americans shoulder more than their share of the tax burden. In 2005, most recent year for which data are available, the top 5% of taxpayers earned 35.7% of the income, but paid 59.7% of the income taxes. The top 1% of taxpayers earned 21.2% of the income, but paid 39.4% of the income taxes. The Democrats running for president, Senators Obama and Clinton, are promising to raise income tax rates on the "rich," but it's hard to see how that can be done much more without putting the burden of funding the whole federal government on a small minority of Americans and starting to raise the whole question of taxation without representation. If the persons paying for the government start to be a substantially different body than the overall population, a country begins to run the risk of serious political strains.

Such concerns are ameliorated somewhat by the data in the Treasury report on income mobility. It found substantial income mobility, with more than half of households moving to a different income quintile between 1996 and 2005. Roughly half of the households in the bottom quintile in 1996 had moved to a higher income quintile by 2005. And more than half of those in the top 1% of earners in 1996 had moved to a lower income group by 2005. Treasury analysis found that income mobility between 1996 and 2005 "was virtually the same as income mobility over the prior comparable period from 1987 to 1996."

The study also underscored that the president's tax cuts helped not only individuals but small businesses. "About 70 percent (1 million) of the 1.4 million tax returns that benefited from lowering the top two tax brackets from 39.6 percent to 35 percent and from 36 percent to 33 percent are flow-through business owners," the Treasury said. The report says that 34 million Americans own some sort of "flow-through" business, one that pays taxes via its individual owners. That includes roughly 4 million S corporations, 4 million partnerships, 22 million sole proprietorships and 2.2 million farms. In other words, the tax cuts affect not only wage-earners but employers and job creators.

One of the papers also underscores that the tax cuts are scheduled to expire at the end of 2010, which would mean significant tax increases for almost all taxpayers. As the Congress and the next administration weigh what to do about these scheduled sunsets, these Treasury reports will be worth keeping in mind.

Obama Stirs Ill Wind on Wall Street

February 29, 2008
Obama Stirs Ill Wind on Wall Street
By Larry Kudlow

Sen. Barack Obama is very gloomy about America, and he's aligning himself with the liberal wing of the Democratic Party in hopes of coming to the nation's rescue. His proposal? Big-government planning, spending and taxing exactly what the nation and the stock market don't want to hear.

Obama unveiled much of his economic strategy in Wisconsin: He wants to spend $150 billion on a green-energy plan. He wants to establish an infrastructure investment bank to the tune of $60 billion. He wants to expand health insurance by roughly $65 billion. He wants to "reopen" trade deals, which is another way of saying he wants to raise the barriers to free trade.

He intends to regulate the profits for drug companies, health insurers and energy firms. He wants to establish a mortgage-interest tax credit. He wants to double the number of workers receiving the earned income tax credit and triple the benefit for minimum-wage workers.

The Obama spend-o-meter is now up around $800 billion. And tax hikes on the rich won't pay for it. It's the middle class that will ultimately shoulder this fiscal burden in terms of higher taxes and lower growth. This isn't free enterprise. It's old-fashioned-liberal tax, and spend, and regulate. It's plain ol' big government. The only people who will benefit are the central planners in Washington.

Obama would like voters to believe that he's the second coming of JFK. But with his unbelievable spending and new-government-agency proposals, he's looking more like Jimmy Carter. His is a "Grow the Government Bureaucracy Plan," and it's totally at odds with investment and business.

Obama says he wants U.S. corporations to stop "shipping jobs overseas" and bring their cash back home. But if he really wanted U.S. companies to keep more of their profits in the states, he'd be calling for a reduction in the corporate tax rate. Why isn't he demanding an end to the double-taxation of corporate earnings? It's simple: He wants higher taxes, too.

The Wall Street Journal's Steve Moore has done the math on Obama's tax plan. He says it will add up to a 39.6% personal income tax, a 52.2% combined income and payroll tax, a 28% capital-gains tax, a 39.6% dividends tax and a 55% estate tax.

Not only is Obama the big-spending candidate, he's also the very-high-tax candidate. And what he wants to tax is capital.

Doesn't Obama understand the vital role of capital formation in creating businesses and jobs? Doesn't he understand that without capital, businesses can't expand their operations and hire more workers?

Dan Henninger, writing in last Thursday's Wall Street Journal, notes that Obama's is a profoundly pessimistic message. "Strip away the new coat of paint from the Obama message, and what you find is not only familiar," writes Henninger. "It's a downer."

Obama wants you to believe that America is in trouble, and that it can only be cured with a big lurch to the left. Take from the rich and give to the non-rich. Redistribute income and wealth. It's an age-old recipe for economic disaster. It completely ignores incentives for entrepreneurs, small family-owned businesses and investors.

You can't have capitalism without capital. But Obama would penalize capital, be it capital from corporations or investors. This will only harm, and not advance, opportunities for middle-class workers.

Obama believes he can use government, and not free markets, to drive the economy. But on taxes, trade and regulation, Obama's program is anti-growth. A President Obama would steer us in the social-market direction of Western Europe, which has produced only stagnant economies down through the years.

It would be quite an irony. While newly emerging nations in Eastern Europe and Asia are lowering the tax penalties on capital and "reaping the economic rewards." Obama would raise them. Low-rate flat-tax plans are proliferating around the world. Yet Obama completely ignores this. American competitiveness would suffer enormously under Obama, as would job opportunities, productivity and real wages.

Imitate the failures of Germany, Norway and Sweden? That's no way to run economic policy.

I have so far been soft on Obama this election season. In many respects, he is a breath of fresh air. He's an attractive candidate with an appealing approach to politics. Obama is likable, and sometimes he "gets it" such as when he opposed Hillary Clinton's five-year rate freeze on mortgages.

But his message is pessimism, not hope. And behind the charm and charisma is a big-government bureaucrat who would take us down the wrong economic road.

Obama's Tax Evasion

Review & Outlook - The Wall Street Journal
Obama's Tax Evasion
April 18, 2008; Page A16

The parsons of the press corps are furious with Charlie Gibson and George Stephanopoulos of ABC News, which means the pair must have done a pretty good job moderating Wednesday's Democratic debate in Philadelphia. Barack Obama had an off-night, so his media choir wants to shoot the questioners.

We thought the debate was one of the best yet, precisely because it probed the evasive rhetoric we've heard from both Democratic candidates throughout the campaign. Nowhere was this more apparent than during the exchanges between Mr. Gibson and Mr. Obama over taxes.
Time and again, the rookie Senator has said he would not raise taxes on middle-class earners, whom he describes as people with annual income lower than between $200,000 and $250,000. On Wednesday night, he repeated the vow. "I not only have pledged not to raise their taxes," said the Senator, "I've been the first candidate in this race to specifically say I would cut their taxes."

But Mr. Obama has also said he's open to raising – indeed, nearly doubling to 28% – the current top capital gains tax rate of 15%, which would in fact be a tax hike on some 100 million Americans who own stock, including millions of people who fit Mr. Obama's definition of middle class.

Mr. Gibson dared to point out this inconsistency, which regularly goes unmentioned in Mr. Obama's fawning press coverage. But Mr. Gibson also probed a little deeper, asking the candidate why he wants to increase the capital gains tax when history shows that a higher rate brings in less revenue.

"Bill Clinton in 1997 signed legislation that dropped the capital gains tax to 20%," said Mr. Gibson. "And George Bush has taken it down to 15%. And in each instance, when the rate dropped, revenues from the tax increased. The government took in more money. And in the 1980s, when the tax was increased to 28%, the revenues went down. So why raise it at all, especially given the fact that 100 million people in this country own stock and would be affected?"

Mr. Obama answered by citing rich hedge fund managers. Raising the capital gains tax is necessary, he said, "to make sure . . . that our tax system is fair and that we are able to finance health care for Americans who currently don't have it and that we're able to invest in our infrastructure and invest in our schools. And you can't do that for free."

But Mr. Gibson had noted that higher rates yield less revenue. So the news anchor tried again: "But history shows that when you drop the capital gains tax, the revenues go up?" Mr. Obama responded that this "might happen or it might not. It depends on what's happening on Wall Street and how business is going." And then he went on a riff about John McCain and the housing market.

This is instructive. The facts about capital gains rates and revenues are well known to our readers, but we'll repeat them as a public service to the Obama campaign. As the nearby chart shows, when the tax rate has risen over the past half century, capital gains realizations have fallen and along with them tax revenue. The most recent such episode was in the early 1990s, when Mr. Obama was old enough to be paying attention. That's one reason Jack Kennedy proposed cutting the capital gains rate. And it's one reason Bill Clinton went along with a rate cut to 20% from 28% in 1997.

Either the young Illinois Senator is ignorant of this revenue data, or he doesn't really care because he's a true income redistributionist who prefers high tax rates as a matter of ideological dogma regardless of the revenue consequences. Neither one is a recommendation for President.
For her part, Hillary Clinton said that she, too, was open to hiking the capital gains tax rate, just not by as much as her rival. "I wouldn't raise it above the 20% if I raised it at all," she said. Of course, she too promised during Wednesday's debate not to raise "a single tax on middle-class Americans, people making less than $250,000 a year."

Both candidates would have voters believe that taxes on investment income only affect the rich. But that's not what Internal Revenue Service returns show. The reality is that the Clinton and Obama rate increases would hit millions of Americans who make well under $200,000. In 2005, 47% of all tax returns reporting capital gains were from households with incomes below $50,000, and 79% came from households with incomes below $100,000.

By the way, a higher capital gains tax rate isn't the only middle-class tax increase that Mr. Obama is proposing. He also wants to lift the cap on wages subject to the payroll tax. That cap was $97,500 in 2007 and is $102,000 this year. "Those are a heck of a lot of people between $97,000 and $200[,000] and $250,000," said Mr. Gibson. "If you raise the payroll taxes, that's going to raise taxes on them." Ignoring the no-tax pledge he had made five minutes earlier, Mr. Obama explained that such a tax increase was nevertheless necessary.

In other words he dodged the question, as he so often does with impunity. But thanks to Mr. Gibson's persistence, for 90 minutes Wednesday night Mr. Obama didn't get away with it. The voters learned a lot about Mr. Obama, who needs to learn a lot more about taxes and revenue.

Obama's Capital Loss

REVIEW & OUTLOOK - The Wall Street Journal
Obama's Capital Loss
April 5, 2008; Page A8

Barack Obama recently released his tax records, and it was notable how little he and his wife appear to invest in the stock market. That may explain the Senator's odd belief that a significant hike in the capital gains tax rate won't matter to shareholders or harm the economy.

Or so Mr. Obama's replied to CNBC's Maria Bartiromo when she asked how much he'd increase the cap-gains tax, something he's said is necessary to restore "fairness" to the tax code. Thanks to the 2003 tax cuts, the top rate is currently 15%.

"When I talk to people like Warren Buffett or others and I ask them, you know, what's – how much of a difference is it going to be if it's 20 or 25%, they say, look, if it's within that range then it's not going to distort, I think, economic decision making," he said. He concluded that a higher rate would boost federal receipts, which would allow the government to redistribute "relief to middle class and working class families."

With apologies to economists Buffett and Obama, the history of this tax isn't on their side. The capital gains rate is crucial to investment decisions; higher rates make capital more expensive, dampening incentives to invest and reducing economic growth. John F. Kennedy understood this, as he proposed a capital gains tax cut. Bill Clinton joined with Republicans in 1997 to sign legislation lowering the rate to 20% from 28%.

Critics howled this would reduce tax revenues, and they howled when Republicans cut the rate to 15% in 2003. What followed in both cases was an enormous "unlocking" effect, as investors sold more stock and assets to take advantage of the lower rate. Capital gains realizations soared to an estimated $729 billion in 2006 from $269 billion in 2002. This goosed Treasury receipts from capital gains, to an estimated $110 billion in 2006 from $49 billion in 2002.

Mr. Obama doesn't have to guess what sort of "distortion" would come from significantly raising the cap-gains rate. In 1986, the tax rate jumped to 28% from 20%, a 40% increase. Tax revenues spiked briefly in anticipation of the hike (as investors moved to cash in at the lower rate), then dropped precipitously. Four years later, in 1990, the federal government was still taking in 13% less revenue at the 28% rate than it did in 1985 at the 20% rate.

As for Mr. Obama's implication that capital gains remain the privilege of the wealthy well, that's yesterday. In recent decades, the U.S. has become a shareholder society, and average Americans increasingly rely on investment income to save for retirement or even to pay bills.

In 2005, according to the most recent data from the Internal Revenue Service, 8.5 million households paid taxes on capital gains. A hefty 47% of those tax filers reported income of less than $50,000, while 79% had income under $100,000. Keep in mind that capital gains themselves count as income and often are a one-time windfall from the sale of a small business or long-held stock. These working families would suffer a double whammy, both with a higher tax rate and lower stock prices – because financial markets factor higher taxes on stock profits into lower stock valuations.

With the economy weak, this is an especially poor time to be talking up tax hikes. A higher rate, and its devaluing of U.S. assets, would hammer U.S. competitiveness, making it harder to attract global capital. America is increasingly isolated in taxing capital gains. Many industrialized competitors publicize a lower rate, and many (Germany, Switzerland, Austria, New Zealand) have no levy at all.

If Mr. Obama really wants to lift the economy – and those middle-class American shareholders – he'd advocate cutting the rate, or indexing it to inflation so investors aren't taxed on phantom gains. That would violate the Democratic left's faith that tax rates don't matter to growth and that raising taxes on capital and "the rich" is good politics. We doubt members of America's politically astute investor class agree.

Blame Barack, Not Charlie & George

Blame Barack, Not Charlie and George
by Larry Kudlow, National Review Online

It’s rather amusing watching the liberal media in full-scale attack mode on George Stephanopoulos and Charles Gibson, with the Washington Post’s Tom Shales as the general leading the charge. Oh my gosh! Their hero Obama has been wounded!

What’s the problem here? Messrs. Gibson and Stephanopolis actually challenged Obama with tough, well-informed questions on tax policy and politics? That’s what they’re supposed to do. At any rate, it’s fascinating to watch members of the mainstream liberal media lunge at each others throats. It’s kind of like watching Hillary and Obama, isn’t it?

Look, here’s the deal: Obama bungled the tax question, big time. Period. End of sentence. End of story. To my liberal friends out there all I can say is: Get over it. Your guy has a very poor grasp of basic economic principles.

First off, you don’t raise taxes during a recession. That’s a no-brainer. Second, doubling the capital-gains tax affects Americans up and down the income ladder, not just rich hedge-fund managers. In addition, capital-gains tax cuts are self-financing, and they stimulate jobs and the economy. You want to raise budget revenues? Cut the cap-gains tax rate. That’s what history shows. Finally, hiking the payroll tax also affects people up and down the income ladder.

Uncapping the payroll tax reveals still another cultural misstep by Sen. Obama. He apparently has a difficult time understanding that nowadays, a veteran fireman or a veteran cop, married to a veteran schoolteacher, will make well over $100,000. In fact, they can make close to $200,000. Yet Obama still wants to go ahead and tax both the first and last payroll dollar of this group at a very high marginal tax rate by uncapping the Social Security (FICA) tax. (Incidentally, I don’t think Mr. Obama knows any cops or fireman. How about that? That is the problem. In other words, his economics are bad and his social circle is very limited.)

But put all this aside for a moment. Obama’s real agenda is a liberal-left ideology that places income redistribution above economic growth. That’s his real message. And looking at the results of presidential elections over the past three decades, Carter, Mondale, Dukakis, Gore, and Kerry all lost with a similar message. Bill Clinton? He was a growth Democrat. So he won twice. But Obama is aligning himself with the Democratic losers. And that will make him a loser as well.

Now, whether Hillary’s pit-bull routine during the debate helped her or not remains to be seen. We’ll learn more on that front come Tuesday when Pennsylvanians head to the voting booths. But that’s a different issue. All I’m saying is that liberals need to quit blaming Charlie Gibson and George Stephanopolis for Obama’s shortcomings. But do blame Obama for failing to grasp the tax penalties he will create on upward mobility for the very people he thinks he’s helping. These same people will be hurt a second time around when the wealthy folks who own capital have less of it — after tax — to invest in new businesses and new jobs.

Charlie Gibson Hammers Obama on Cap-Gains

Gibson Hammers Hillary-Obama on Cap-Gains
by Larry Kudlow, National Review Online

ABC’s Charlie Gibson did a heck of a job advancing the supply-side ball during last night’s Democratic debate. Gibson presented clear evidence that whenever the capital-gains tax rate has been cut in the past twenty years, tax revenues have shot up, while the one time the rate was raised — surprise, surprise — revenues headed south. Gibson then confronted Obama with his promise to essentially double the capital-gains rate if he were elected president.

Obama didn’t budge. The reality that a lower cap-gains rate brings in more government tax revenue didn’t faze him one bit. Apparently, nor does the fact that raising the cap-gains rate diminishes jobs, enervates capital formation, and leads to lousy economic growth. Obama’s response and sole concern remains sticking it to rich people, like hedge-fund managers.

Someone ought to point out to Sen. Obama that of the 8.5 million tax filers who declared capital gains in 2005, 79 percent had incomes under $100,000. Seventy-nine percent! The unfortunate fact is that Wall Street won’t be the only one hit hard by Obama’s populism. Main Street will be hit even harder.

Obama's No Fan of Retirement Savings

Obama: No fan of retirement saving
by Greg Minkiw

A key feature of the U.S. tax system is the option to put some income into tax-deferred savings accounts, such as IRAs and 401(k) plans. These accounts make the tax system a bit like a consumption tax rather than a true income tax in the sense that some part of saving gets exempt from taxation until it is later withdrawn and consumed. Many economists believe that consumption taxes are better than income taxes because they do not distort the intertemporal margin between consumption today and consumption in the future. Many financial advisers encourage people to put as much as they can into these retirement accounts.

I was surprised to see that Senator Obama has, for some reason, decided not to use this opportunity. His recently released tax returns show significant Schedule C income from book royalties (about half a million dollars in the most recent year). I am not a tax accountant, but I believe he could have put a substantial part of these earnings ($44,000) into a SEP-IRA and deferred taxes on it until withdrawal. Line 28 on his tax return, however, is completely blank.

Why? I don't know. Maybe he is getting bad tax advice. Or maybe he is expecting vastly higher tax rates in the future when the accumulated savings will need to be withdrawn and taxed. As Obama economic adviser Austan Goolsbee has written, "Future increases in tax rates potentially threaten to significantly reduce the value of your retirement savings and may even mean that you should not save in 401(k) accounts at all."