Presidential candidate Barack Obama’s mantra for change in economic policies amounts to this: a huge increase in redistribution of income at the hands of the federal government. While Obama refers to this as a “net” tax cut, raising taxes on the top 5 percent and lowering taxes or increasing outright benefits for the other 95 percent simply amounts to an indisputably massive increase in redistribution and ultimately very little meaningful change.
To hear Obama and other Democrats describe our current policies, one might think that we do very little to help the poor and disadvantaged. But Americans already transfer more than a trillion dollars a year to low-income households. That’s a lot of money. Before we endorse Obama’s agenda of more of the same, shouldn’t we ask him what benefits a trillion dollars a year have yielded so far? Has that money reduced dependency? Has it solved the problems associated with poverty and inequality? Are more disadvantaged children being raised in stable two-parent families today than 50 years ago?
Moreover, this amount is twice what we spend annually on national defense and seven times our current annual expenditures on the war in Iraq. In fact, it is equal to the entire before-tax income of middle-income households (those between the 40th and 60th percentiles). If a trillion dollars a year is not enough to produce substantial benefits in these and other areas, why should we expect more spending to do any better?
Obama proposes several “changes” (or more accurately, increases) in tax and welfare programs, which, again, are misleadingly referred to as a “net” tax cut. These changes, however, have the effect of increasing the marginal tax rates confronting virtually all Americans. The marginal tax rate is the rate that applies to any extra earnings, and it acts to distort economic incentives to work, save, invest, and report income. As marginal tax rates rise, we get less work, saving, investment–”in short, less economic growth.
The federal marginal tax rate applied to the top 5 percent will rise from about 38 percent to more than 50 percent as a result of Obama’s tax changes. But surprisingly, most of the 95 percent who supposedly get a “tax cut” will also confront higher marginal tax rates. This occurs because the various proposed refundable tax credits (really, welfare benefits) are phased out as income rises; this take-back has exactly the same effect as taxing any increase in earnings. In fact, many low income Americans already confront effective marginal tax rates in excess of 50 percent due to the phase-outs in the more than 80 welfare programs we already have.
Since Obama believes that “in America, prosperity has always risen from the bottom up,” he should be genuinely concerned with imposing higher marginal tax rates on non-rich Americans. But economists will be more concerned with the higher rates on that top 5 percent because we know that the “rich” play a crucial role in financing the economy’s investments and new business start-ups and in producing the technological innovations so critical to improving our prosperity. Higher marginal tax rates on the “rich” are certain to reduce the contributions they make to the well being of all Americans.
Increasing marginal tax rates as Obama proposes may in the short run improve the material well-being of lower income Americans (at the expense of higher income Americans), but in the long run it will lead to slower economic growth and lower incomes for most people in the future. Economic research suggests that our current redistributive policies have already reduced the average American’s before-tax income by 25 percent. This is the hidden cost of redistribution that is well documented in economics literature, but rarely acknowledged in media discussions. That cost will become larger in the future if Obama’s economic agenda is put into place.
Economists know that no economy has ever redistributed its way to prosperity, but many have had the opposite result. Perhaps Barack Obama can buck the odds, but don’t count on it.