Sunday, February 22, 2009

Obama's Budget Plans

We can see Obama's budget plans in this article in the Washington Post. His plan is indeed ambitious, but I for one certainly think it sounds very good. Borrowing the WaPo summary of the plan

To get there, Obama proposes to cut spending and raise taxes. The savings would come primarily from "winding down the war" in Iraq, a senior administration official said. The budget assumes continued spending on "overseas military contingency operations" throughout Obama's presidency, the official said, but that number is lower than the nearly $190 billion budgeted for Iraq and Afghanistan last year.

Obama also seeks to increase tax collections, mainly by making good on his promise to eliminate some of the temporary tax cuts enacted in 2001 and 2003. While the budget would keep the breaks that benefit middle-income families, it would eliminate them for wealthy taxpayers, defined as families earning more than $250,000 a year. Those tax breaks would be permitted to expire on schedule in 2011. That means the top tax rate would rise from 35 percent to 39.6 percent, the tax on capital gains would jump to 20 percent from 15 percent for wealthy filers and the tax on estates worth more than $3.5 million would be maintained at the current rate of 45 percent.

Obama also proposes "a fairly aggressive effort on tax enforcement" that would target corporate loopholes, the official said. And Obama's budget seeks to tax the earnings of hedge fund managers as normal income rather than at the lower 15 percent capital gains rate.

All of these are appropriate and helpful steps to take. From my position on the role of government in society and the economy (see here, here and here for example) it is my opinion that the taxes we charge to middle and lower income citizens are way too high and the rates we charge to wealthier citizens, those whose income and wealth are most dependent upon the services provided by the government are way too low. Increasing taxes at the high end and lowering them at the low end of the income range will only serve to boost the economy. There are plenty of folks at the lower end of the income scale who are interested in expanding their economic activity, people who wish to be wealthy but who are not, but have limited access to fresh capital needed to do so.

Look, as a general rule, folks will do more work, and create more new wealth as their expenses rise in comparison to their income. As that difference narrows, people will, whatever their income, do more work and take less leisure. Likewise, as the gap grows (in favor of higher income and lower costs) they will trade further increase in income for leisure time. This is as true of the corporate CEO or fund manager as it is of the hourly wage earner and everyone in between. For people at the lower end of the income range the options when expenses are high compared to income are to take another job or to work more hours or the like. For the manager of a business the options are to also work more hours, but that entails using the resources of the business to create and sell more product. This, in turn, involves hiring more people, paying more wages and stimulating the economy.

So we can see why our economic policies of the past eight years are so foolish. As I have argued in the links above, part of the cost of running a large business in this country are services provided by the Federal Government. Services like copyright protection, incorporation, licensing the electromagnetic spectrum (radio and TV), etc. The Bush era plan to stimulate the economy then has been to consistently cut the costs the businesses have. But this can only serve to increase the gap between income and costs and thus decrease the manager's interest in working to create new and more product. Now in any plan that involves cutting taxes, some additional money will be spent and some stimulus to the economy will be observed. However, the effect will be weak, as it has been for the past eight years. The other effect that I am discussing here, the reduced willingness of the business manager to produce, will also be observed, and it has.

This chart (h/t to Mark Kleiman and Quincy Adams) illustrates what I am discussing. The upper chart shows industrial production, capacity and utilization over time since 1965. The striking thing about the chart is the high level and rapid increase in these value during the Clinton years and the subsequent slowdown and then drop off during the Bush years. With tax rates higher during the Clinton years, people running large businesses needed to produce more and create better products if they were going to enjoy an increase in personal income and wealth. Under the Bush administration, with a nearly guaranteed increase in personal income for the people owning and running the businesses (an increase in their income because the government would certainly reduce their costs, even if they worked and produced less) we see they took more leisure time, produced less and production and utilization slowed down.

Another example of the result of the Bush policies is the quality of our broadband services in this county, discussed by Matt Yglesias, here for example. For a telecom company to improve the boradband services it provides would require a fair amount of efffort to be supplied by the owners and operators of the business. In a capitalist, market based system, the people running a telecom company are motivated to put forth the effort needed to improve broadband service (or any other service for that matter) by a desire to increase their own income and wealth. For the past eight years we have, however, been guaranteeing that they will see an increase in their wealth and income even if the don't do this work, and shock of shocks they have been, by and large, taking the increase income without doing the incrrease effort. The policies of the past eight years have been for the general citizens to do with poorer service and lower value to the products in order to guarantee that the owners of these firms can enjoy great wealth without having to work. This is a foolish policy.

A return to higher taxes for these folks will not raise prices, it will increase the amount of production. To do that will require an increase in employment. All to the good for we citizens who have the responsibility to set the prices that government charges industry for government services. We can also see the effect of these policies in the income and wealth of citizens across the income spectrum in these charts provided by Nate Silver. As indicated, the wealth and income of everybody was higher during the Clinton years, and more equally distributed. This is the expected effect of Obama's plans on taxes and Federal spending. All to the good, again, for the vast majority of citizens.

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