Obama’s Tax Policy: None Dare Call It Welfare

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
January 13, 2009

IN THIS ISSUE:

1. Obama Pushes His Stimulus Plan

2. Dick Morris – Tax Exempt Tyranny?

3. More On Obama’s Plan From Peter Ferrara

4. It Depends Upon Your Definition Of “Tax Cut”

Introduction

I had originally planned to write about the Bernie Madoff scandal this week. In fact, I had already written the E-Letter that described how Madoff swindled investors out of tens of billions of dollars in a giant Ponzi scheme. Maybe I’ll send that one to you next week.

But just in the last few days, we have learned the details of President-elect Obama’s massive income tax overhaul, and the plan is much worse than we had anticipated. And you need to know about it ASAP, since it will negatively affect most of you who read this E-Letter on a regular basis.

Obama’s liberal tax plan would give annual tax rebates to millions of Americans who already pay no income taxes whatsoever. Giving government tax rebate checks to those who already pay zero income taxes is nothing short of expanding the welfare state (or socialism as I prefer to call it).

Worst of all, if Obama gets his massive tax plan approved, it will mean that a majority of Americans will pay little or no income taxes, while the so-called “wealthy” will foot the rest of the bill. If we reach such a point, there will be little to no chance of true tax reform for the foreseeable future.

While the “rich” can afford to pay higher income taxes, it is this same group that creates most of the new jobs in this country. As we have seen often in the past, when the government unduly taxes the “rich,” job creation grinds to a halt. We can hardly risk that in the current economic recession and credit crisis.

To get you the information you need to know, I have reprinted two articles below that are right on point. The first is from political writer Dick Morris who was a top advisor to Bill Clinton, who has since converted to a conservative. The second is from Peter Ferrara who is director of budget and entitlement policy at the Institute for Policy Innovation and general counsel for the American Civil Rights Union.

Together, these two articles expose the fallacies of Obama’s proposed tax policies. Please read what follows closely. If Obama gets his way (and he probably will), it will affect us in profound ways, which is part of his grand plan. Hint: it will affect your pocketbook!

QUOTE:
"Obama Stimulus Fosters Tax-Exempt Tyranny
by Dick Morris & (wife) Eileen McGann

It now looks like half of President-elect Barack Obama's stimulus package will take the form of "tax cuts" for 95 percent of all Americans. Yet this wouldn't boost the economy as much as trigger a massive, unhealthy shift in American politics.

Under Obama's plan, the majority of American voters would pay no federal income taxes but would get money from the government instead. That is, these "refundable tax credits" are basically welfare checks — and Obama's plan would leave the most of us collecting, not paying.

A $200 billion giveaway won't do much to get a $14 trillion economy rolling again. But the plan would leave any future taxpayer revolt no hope of majority support.

Today, the bottom 50 percent of U.S. taxpayers pays a total of $30.6 billion in federal income taxes on a combined income of about $1 trillion. So about 3 percent of all federal income-tax payments come from the poorest half of the country. (The top 1 percent pays 40 percent; the top 25 percent pay 85 percent of the federal income tax.)

Obama's plan — he'd give all couples a $1,000 refundable tax credit and all single people $500 — would funnel more than $50 billion to the lowest half of the country, thereby completely wiping out their total federal tax liability. In most cases, it would trigger a "refund" welfare check.

In one stroke, this would transform the majority of voters from taxpayers into tax eaters, and leave an increasingly small minority to pay the bill. Regardless of whether this is good economics, it is very dangerous politics.

Essentially, it would put those who actually pay the taxes that fund our government into much the same situation as landlords in New York City: hopelessly outvoted by their tenants, who use their political clout to limit rents and landlords' profits.

Since Ronald Reagan, the anti-tax movement has been based on a blue-collar revolt against high taxes; it would lose that constituency under the Obama plan. Taxpayers would be politically helpless and the tax-eating majority would have free reign to impose any levies it wished.

Almost all of the 68 million tax filers in the country's bottom economic half would get checks from Washington at tax time. Some would be among the 22 million who get money from the Earned Income Tax Credit. Others would get a $500 check through the (Bush-passed) Child Tax Credit — and all would get funds through the new Obama tax credit.

Welfare no longer would be only for the poor because the majority of the voters would depend on government handouts. This very system is what makes European social democracies so resistant to change.

In 1980, the bottom 50 percent of the nation paid 7 percent of the national tax bill, after refund and credits. It now pays 3 percent; under Obama's plan, it would pay less than nothing (that is, it would net a profit from the IRS). In 1980, the top 1 percent paid 19 percent of the income-tax burden; now, it's 40 percent. Taxes have become the province of only the rich.

Of course, the shift in tax burden also mirrors the incredible increase in incomes of the wealthy during the past 30 years: The top 1 percent earned only 8 percent of the total national income in 1980; now, it earns 22 percent. And the poorest half has seen its share of national income fall from 17 percent in 1980 to only 12.5 percent today.

So it is both fair and sensible to give the poor a tax break and to draw the bulk of federal revenues from the rich. But to exempt the bottom half — a majority of the voters — from paying any taxes and to award them refund checks instead would dangerously alter the fundamental balance of national politics. For the economically well off, it effectively could become taxation without representation, which, as the founders of our nation warned, leads to tyranny." END QUOTE

I trust that most of my readers can fully understand the implications for high net worth investors if Obama gets his way, as looks increasingly likely. Now let’s take it a step further with another thought-provoking article from Peter Ferrara, another high-level source. Read closely.

QUOTE:
"The Tax Cut Mirage
by Peter Ferrara

Obama Eyes $310 Billion in Tax Cuts" the headline blares. The Obama team comes to town to start the new year, and the run-up to his inauguration, with this announcement. How sly.

This Obama tax cut package is to be part of the broader stimulus package now estimated to cost $775 billion. The problem is that there are tax cuts and there are tax cuts, and there are other things Obama calls tax cuts that are not even tax cuts. The "tax cuts" Obama is proposing for his stimulus package, like the rest of his stimulus package, are not going to stimulate anything.

Tax cuts do not stimulate the economy by "putting money in people's pockets" which they can then spend, as even some Republicans, including George Bush, mistakenly say. That's an old-fashioned Keynesian strategy, and, if it worked, the same result could be achieved by sending out increased welfare checks, which also puts money in people's pockets, which they can spend. But it doesn't work, because it doesn't do anything to change the basic incentives governing the economy, and because just borrowing money and then sending it out to people, in "tax rebate" checks or welfare checks, doesn't add anything to the economy on net.

Tax cuts stimulate the economy when they involve reductions in tax rates. The reduction in rates improves incentives for savings, investment, business creation and expansion, job creation, entrepreneurship, and work, by allowing people to keep a greater percentage of the reward produced by these activities. This improves the economy not just by the dollar amount of the tax cut. The improved incentives affect every economic decision and every dollar in the entire economy. The astoundingly successful Reagan tax cuts in the 1980s, as well as the astoundingly successful Kennedy tax cuts of the 1960s, were both based on reducing tax rates, and were successful for these reasons.

But the Obama tax cut package studiously avoids any reductions in tax rates anywhere. The centerpiece of the plan is a $500 per worker tax credit, estimated to cost $150 billion. The government will just borrow $150 billion from the private economy to give away in these tax credits, so there will be no net gain to the economy. Nor will there be any improved incentives to save, or invest, or start or expand a business, or hire new workers. The credit does not even provide increased incentives to work, because once the worker is over a very low income threshold of about $8,000 per year, the amount of the credit does not increase for increased work and income.

Notice that these arguments apply even for workers who do pay considerable income taxes. Suppose you work and earn enough to pay $5,000 per year in income taxes. The Obama tax credit will reduce your income taxes by $500. In this case, the credit is a real tax cut. But it still will not stimulate the economy for the reasons stated above, it does not add to the economy on net and it does not improve incentives. It is a Keynesian tax cut, not a supply-side tax cut, because it is a flat cash rebate, effectively the same as more government spending, not a reduction in rates.

Keynesians think that the way to increase economic growth is to increase deficits and government spending. We tried that in the 1970s, and we got inflation along with ever worsening recessions. We tried it in the 1930s, and we got the Great Depression lasting for over 10 years. It doesn't work.

Indeed, the Wall Street Journal news story on the Obama tax package says regarding this $500 per worker tax credit, "This part of the plan is similar to a bipartisan initiative launched in early 2008, which sent out checks worth $131 billion." Precisely. Bush and the Democrats joined together a year ago to agree on a stimulus package sending out $131 billion in "tax rebates" to workers all across the country. Those tax rebates were very similar to Obama's tax credits today. They involved no reduction in tax rates, or improved incentives anywhere. They were based on a Keynesian rationale, just like Obama's tax credits -- stimulate the economy by increasing government deficits and providing cash rebates for people to spend.

And, of course, that tax rebate stimulus package from a year ago didn't work. The economy continued to worsen throughout the year, and financial markets collapsed in the fall. Henry Paulson was back in September asking for another $700 billion, to save the economy supposedly from complete collapse, and another Depression.

Then there is the part of the Obama tax cut that is not a tax cut. The bottom 40% of income earners do not pay income taxes on net. The $500 per worker Obama income tax credit will consequently not reduce income taxes for these workers. It will involve instead another check going from other taxpayers to these workers, which is actually just increased government spending, indeed, increased welfare.

Indeed, another part of the Obama tax cut plan is even more overt. Obama proposes to include in that plan an increase in the scandal-ridden Earned Income Tax Credit (EITC). The EITC goes to the lowest income workers, who do not pay federal income taxes, and it is universally recognized as a welfare program. In this, as in other provisions of the overall stimulus package, Obama and the Democrats are effectively arguing that they are going to stimulate the economy by increasing welfare. Reagan and the Republicans stimulated the economy by cutting marginal tax rates, providing incentives to save, invest, produce, start and expand businesses, and create jobs (as Kennedy and the Democrats did in the 1960s). Now Obama and the Democrats claim they are going to do the same by increasing welfare and government spending.

Obama tries to argue that his $500 per worker income tax credit is a tax cut even for workers who do not pay income taxes because these workers still pay payroll taxes for Social Security and Medicare. But the only connection between this tax credit and payroll taxes is purely rhetorical. If Obama wants to claim credit for a cut in payroll taxes, then he can propose a cut in payroll taxes. Then Obama can tell us how much sooner the Social Security trust funds will run out and leave the program bankrupt because of his tax credit. The answer in regard to Obama's $500 per worker credit is zero, because that credit does not involve a reduction in payroll taxes of any sort; it is an income tax credit, not a payroll tax cut.

Another component of the Obama $310 billion "tax cut" package is a proposal for a one-year tax credit of $3,000 to businesses for each new job created, costing a pricey $40 billion to $50 billion. Congress already adopted a similar plan proposed by former Sen. Dan Quayle back in the 1980s, called the Targeted Jobs Tax Credit (TJTC). Over the years this has been changed into the Work Opportunity Tax Credit (WOTC), which provides $2,400 for each new adult worker hired, $4,800 for hiring a disabled veteran, and $9,600 for hiring welfare recipients, high risk youths, and qualified ex-felons. It is unclear whether Obama is aware of this history, but his tax credit is not going to produce any more hiring than the already existing WOTC.

Studies of these tax credits over the years have concluded that the credits have mostly gone for workers that would have been hired anyway, with little if any net new jobs created. And this does not include the jobs lost from the private sector when the government borrowed the additional funds to cover the tax credits. Steve Entin of the Institute for Research on the Economics of Taxation argues that such a tax credit is unlikely to stimulate much employment when the economy is down and businesses are not expanding. "Given the current degree of uncertainty about where the economy is headed," he writes, "the credit is not likely to achieve much for many months, until we are already on the upturn, at which time it would not be needed."

Other provisions of the overall stimulus package follow on the theme of stimulating the economy through increased welfare and government spending. The plan includes major expansions of unemployment compensation, including extending unemployment insurance to part-time workers. It also includes increased Medicaid coverage, and subsidies for employers continuing health insurance for laid off workers. Another $140 billion to $200 billion would go for aid to states to be spent on Medicaid and education. The government's borrowing hundreds of billions for such spending is not going to stimulate anything. It may produce a drag on the economy by increasing dependency.

Then there is another couple of hundred billion for increased spending on infrastructure, including building and renovating roads, highways, bridges, and schools, and making government buildings more energy efficient. Such infrastructure spending was the central strategy Japan used to counter its severe economic downturn of the 1990s, which nevertheless continued for over 10 years. In the U.S., these infrastructure projects take years to get up and running, and are often bogged down by lawsuits relating to the environment and other factors, leaving such projects unsuited for short-term stimulus spending. In any event, again, government borrowing of hundreds of billions for such increased spending would not add anything to the economy on net.

The Wall Street Journal reports Obama transition spokeswoman Stephanie Cutter as saying, "We're working with Congress to develop a tax cut package based on a simple principle: What will have the biggest and most immediate impact on creating private sector jobs and strengthening the middle class? We're guided by what works, not by any ideology or special interests."

This propaganda spin is exactly the opposite of what Obama is doing. Obama is studiously avoiding exactly what would work, with the biggest and most immediate impact, because he is so ideologically opposed to the pro-growth, free-market policies that would produce that result. Instead, his ideology is leading him to exactly what will not work to promote an economic recovery, increased welfare, government spending, and trillion dollar deficits. Here is what would work.

The Republicans should advance a proposal that would sharply reduce the 25% income tax rate that applies to the middle class to 15%. This would leave 90% of workers with a flat rate tax of 15%, or even less. Such reduced tax rates would provide real incentives to stimulate the economy, as discussed above. A bill providing for this should be introduced as soon as possible, to get the debate going. This proposal serves as an alternative to the rest of the Obama tax plan to be introduced later, as well as the stimulus package. Senate Minority Leader Mitch McConnell raised precisely this proposal last Sunday. Bravo.

Other proposals would promote economic recovery and growth even more. Most urgent, in terms of producing the biggest and most immediate pro-growth impact, is to reduce the outdated and uncompetitive federal corporate tax rate of 35% at least to 25%, if not the 19% recently adopted by Germany and Canada. The Bush tax cuts for capital gains and dividends should be made permanent. Also urgent would be to adopt immediate expensing, meaning deductions, for investment in capital equipment, rather than depreciation, which drags the deductions out over many years. This would have the same effect as a rate reduction for investors, by increasing the percentage of the reward that such investors could keep. A true economic boom would be created if Congress also reduced the top marginal income tax rate to 25%.

But McCain proposed most of these ideas, and Obama ridiculed them, and Obama won. So Republicans should not expect to be able to advance such ideas effectively in Congress right now, especially since they are in such a distinct minority. Conservative commentators can and should promote these ideas as the real effective and practical ways to promote economic growth and get America booming again, and Republicans can run on them in future races. But the one idea that Republicans can effectively advance right now politically is the middle class income tax rate reduction discussed above.

Another urgent, pro-growth reform is deregulation to allow drilling for oil and natural gas, offshore and onshore in ANWR and elsewhere, and renewed expansion of nuclear power production. This would promote economic growth both by reviving a powerful energy industry in America, and by providing low cost, reliable supplies of energy to the rest of the economy. Removing any regulatory barriers to development and production of alternative energy would be very helpful as well. But an alternative energy industry built on massive government subsidies would be a net drag on the economy.

Republicans and conservatives should be careful to note that the inherently powerful American economy retains natural tendencies to recover. They should not preclude that possibility in criticizing the Obama/Democrat stimulus package. Economic growth may well return later this year regardless of what Obama and the Democrats do.

But neither can we allow Obama to pose unchallenged as proposing enormous tax cuts when they are mostly a mirage, or worse, actually increased government spending and welfare, rather than tax cuts. We must start aggressively advancing that argument now, and the case more generally against Keynesian government spending and enormous deficits as the keys to recovery, and aggressively offer instead the real policies that would restore growth and prosperity, and set off a new economic boom." END QUOTE

[Peter Ferrara is director of budget and entitlement policy at the Institute for Policy Innovation and general counsel for the American Civil Rights Union. He formerly served in President Reagan's White House Office of Policy Development, and as Associate Deputy Attorney General of the United States under the first President Bush. He is a graduate of Harvard College and Harvard Law School.]

Conclusions

President-elect Obama’s tax cut proposal has been criticized by many conservatives (and even some moderates and liberals) for being misleading because he says that it will benefit 95% of American households. Supporters, however, claim that the promise is legitimate and even some objective, third-party analysis has supported its merits. So who’s telling the truth?

That’s a very good question. I find it interesting that anyone can come to the conclusion that an income tax cut will benefit 95% of American households when the non-partisan TaxPolicyCenter estimates that approximately 38% of income tax filers pay no tax at all! To make Obama’s statement true, you have to resort to an old Democratic tradition and ask what the meaning of ‘tax cut’ is.

The secret of how the common-sense definition of reducing income taxes somehow morphs into a plan that benefits individuals who currently pay no income tax is a tale of political slight of hand at the highest level. After all, how can you reduce the income tax bite for someone who already pays NO income taxes? It sounds impossible, doesn’t it? If your tax rate is effectively zero, then it would seem that you are already benefiting from the master design of a progressive tax system that increases rates as incomes go higher, right?

Wrong! (At least according to Obama and Congressional Democrats)

In today’s world of political spin, a tax cut proposal need not apply only to those with income tax rates above zero. Instead, today’s definition of a tax cut can include allowing those who already pay no income taxes to receive a check from the government. Let me make it clear, I’m not talking about getting a refund of all of the income tax withheld from pay. No, we’re talking about receiving a government check over and above all of the withholding. In effect, it amounts to a negative tax rate for those who qualify, which is reportedly going to be over 50% of American households.

This negative tax rate is officially deemed to be a “refund,” since certain tax credits are deemed to be “refundable,” meaning that they are payable even if the filer’s total tax bill is zero. Excuse me, but a “refund” used to be defined as a return of something that you had paid in. But that’s not the case in the fairy tale world of Washington, DC. In Obama’s plan, you can get something called a refund even though it really represents a check from the government drawn from all those unfortunate souls who actually had to pay income taxes. Can you say WELFARE?

Thus, in today’s political world, we need to alter our common-sense definitions of some key terms, as follows:

Tax cut = Receipt of other people’s tax money (but don’t call it welfare or redistribution of wealth)

Refund = Check from the government that may or may not include any money you have actually paid in.

Taxpayer = Tax receiver, unless you have worked hard to earn a lot of money, and then the old definition applies.

Welfare = An outdated, politically incorrect word that used to mean government assistance. For the new definition of government assistance, see “Tax Cut” above.

Redistribution of Wealth = A socialist philosophy generally unacceptable to capitalist societies unless repackaged under another definition found to be more palatable to the general public. See “Tax Cut” and “Refund” above.

If Obama wants to put money in the hands of people in an effort to stimulate the economy, then he should proceed as Bush did last year and dole out checks to the populace. I don’t particularly agree with the practice, but at least people would know what is happening.

To dress a government handout (more welfare) in the garb of a tax cut can have some very drastic and negative effects, in my opinion. First, as Dick Morris points out, it means all income tax receipts will come from the top 50% of wage earners. I still happen to be in the camp of those who believe that you hold government more responsible when part of the money is yours. Plus, it makes changing the current complexity-laden tax code virtually impossible since the alternatives such as a “Flat Tax” or “Fair Tax” would mean that the 50% who pay no taxes would have to start paying taxes again.

Another big negative is that the majority of voters can elect representatives that will pass laws with no tax consequences to the bottom 50%. Why not vote for expanded social services, it won’t cost them anything, and they may even get a bigger government check. Can you say welfare? Or socialism?

Lack of participation in the funding of government is not a good thing. Alexis de Tocqueville, a 19th Century thinker, said, “A democracy cannot exist as a permanent form of government. It can exist only until the voters discover they can vote themselves largess out of the public treasury. From that moment on, the majority always votes for the candidate promising the most benefits from the public treasury, with the result that democracy always collapses over a loose fiscal policy, always to be followed by a dictatorship."

Don’t look now, but it looks like the time when the majority of American households that receive from the government, rather than pay any income taxes, is about to be upon us.

Very best regards,

Gary D. Halbert