November 02, 2008
Fiscal Implications of the Candidates' Plans
I think now is the time to consider the fiscal implications of the candidates' budget -- and particularly tax -- plans, especially considering the revenue declines and outlays that will confront the next President. Indeed, I would say imminent revenue declines will place an even greater premium on sensible tax plans, and efficient use of Federal dollars. Figure 1 displays the budget surplus to GDP ratio, both actual and CBO baseline.
Figure 1: Federal budget balance to GDP ratio (thick dark green), baseline (green), EGTRRA/JGTRRA extended (purple), baseline with Obama tax plan as stated by campaign staff (blue), baseline with McCain plan as stated by campaign staff (red), and Deutsche Bank estimate for FY 2009 (teal square). All dates pertain to fiscal years. Sources: CBO, The Budget and Economic Outlook: An Update (September 2008) Table C-2, Table 1-8 [xls], 2008 deficit data from October Monthly Budget Review, Williams and Gleckman, "A Updated Analysis of the 2008 Presidential Candidates' Tax Plans," (Tax Policy Center, Sept. 15, 2008), Chowdhury and Huie, "Skyrocketing Issuance," US Economics/Strategy Weekly (Deutsche Bank, 10 Oct.) and author's calculations.
Figure 1 also reports the alternative ratio if the 2001 and 2003 tax cuts (EGTRRA and JGTRRA) are extended (but not including AMT fixes). What is noteworthy is that if Obama's plan (as evaluated on September 15 by the Tax Policy Center) is implemented, then -- excepting the first couple years, the budget balance mimics the baseline plus extending EGTRRA/JGTRRA. On the other hand, the McCain's plan implies a substantial deterioration relative to even the baseline plus tax cut extension. The McCain plan induces budget deficit to GDP ratio nearly 1 percentage point larger than the Obama plan by FY2018. (Note: I have used the revenue implications as indicated under "Tax Proposals as Described by Campaign Staff" in the following table):
Table from Williams and Gleckman, "A Updated Analysis of the 2008 Presidential Candidates' Tax Plans," (Tax Policy Center, Sept. 15, 2008).
Let me stress what I think is the key take-away from this table: the total revenue loss FY2009-18 under the McCain plan is $4170.5 billion, as compared to the $2947.6 billion loss relative to CBO current law baseline. So the McCain plan implies a $1.2 trillion extra revenue loss. Alternatively, the McCain plan implies a 41.5% greater tax revenue loss than the Obama plan.
Figure 1 also depicts the DeutscheBank estimate for FY2009 budget deficit. From the report (not online):
For the on-budget contribution to issuance, we are expecting a $775 bn deficit in FY 2009. This is based on the CBO baseline, adjusted for increasing baseline expenses, falling revenue (particularly from corporate income taxes), potentially large fiscal initiatives, and a fiscal stimulus package from the new Administration that would all add up to a near doubling of the traditional measure of the budget deficit. For our estimate, we are assuming $100 bn outlays for FDIC rescues and as a fiscal stimulus, as well as $35 bn above the baseline for purchases of GSE preferred stock. The actual outcome relative to our budget deficit estimate is biased upward, since there could easily be a larger fiscal package, the FDIC outlays could move sharply higher if more banks fail, and tax revenues could fall if the economy enters into a deep recession.
This excerpt highlights the fact that the world, and the macroeconomic and budget outlook, have changed drastically since September 15th, when these revenue implications were tabulated.
Since then, the candidates have released new spending initiatives. The fiscal implications are examined in this Tax Policy Center report, entitled The Presidential Candidates' New Tax Proposals (October 28):
In response to the deterioration of the economy and the decline in asset values, Senators McCain and Obama have offered new proposals related to unemployment compensation, retirement savings, taxation of capital gains, and job creation. Although the proposals would provide some benefit, they have significant shortcomings.
In response to the deterioration of the economy and the decline in asset values, both presidential candidates offered new proposals related to unemployment compensation, retirement savings, taxation of capital gains, and job creation. Although the proposals would provide some benefit, they have significant shortcomings.
Senator McCain proposes to exempt unemployment compensation from federal income tax in 2008 and 2009 for most taxpayers, suspend required distribution rules for IRAs, lower the tax on some withdrawals from retirement savings accounts, increase the limits on the deductibility of capital losses, and lower the tax rate on long-term capital gains. Senator Obama would eliminate all taxation of unemployment compensation, allow limited penalty-free withdrawals from retirement savings account, and provide firms a refundable credit of $3,000 for each additional employee they hire. All of those proposals would be temporary and expire by 2010 or 2011.
Most of the proposals are very poorly targeted and would do very little to address the fundamental problems caused by the economic downturn. The proposal to eliminate tax on some or all unemployment benefits, for example, which is supported in different forms by both candidates, would most help unemployed workers who have substantial other income. A better option would be to extend unemployment benefits for workers who suffer long spells of unemployment. Most of the other proposals would do little good and could have unintended and counterproductive side effects.
It strikes me that these tax-based initiatives are ill-suited to countering the impact of recession, and the tabulation buttresses my view that stimulus should be oriented toward transfers and spending on goods and services, as discussed in this post on multipliers.
Table from Committee for a Responsible Federal Budget, Guide to Stimulus Proposals: The 2008 Presidential Election (released October 31).
Note that, while the price tag of McCain's plan is $52.5 vs. $186.5 to $190 billion for Obama's, this calculation requires that the $300 billion McCain plan to buy distressed mortgages is funded out of the $700 billion TARP funds.
While these are big numbers, I think they are still dwarfed by the tax policy impacts, illustrated in Figure 1.
A last point. Figure 1 depicted the deficit impacts taking the campaign staff numbers as given. However, the Tax Policy Center (a joint Urban Institute/Brookings Institution) has conducted its own analysis based upon the candidates' stump speeches (second panel in the table). This yields the implied deficits illustrated in Figure 2.
Figure 2: Federal budget balance to GDP ratio (thick dark green), baseline (green), EGTRRA/JGTRRA extended (purple), baseline with Obama tax plan as indicated in stump speeches(blue), baseline with McCain plan as indicated in stump speeches(red), and Deutsche Bank estimate for FY 2009 (teal square). All dates pertain to fiscal years. Sources: CBO, The Budget and Economic Outlook: An Update (September 2008) Table C-2, Table 1-8 [xls], 2008 deficit data from October Monthly Budget Review, Williams and Gleckman, "A Updated Analysis of the 2008 Presidential Candidates' Tax Plans," (Tax Policy Center, Sept. 15, 2008), Chowdhury and Huie, "Skyrocketing Issuance," US Economics/Strategy Weekly (Deutsche Bank, 10 Oct.) and author's calculations.
This graph highlights the fact that the McCain plan implies a substantially more serious deterioration in the fiscal balance than the Obama plan: -$6,953.5 billion versus -$2,557.4 billion, over FY2009-18, a $4396.1 billion difference. In other words, the McCain plan implies a 171.9% larger reduction in revenue relative to current law baseline than the Obama plan, as scored by the Tax Policy Center. (Of course, the McCain plan does include substantial unspecified spending reductions, but these are akin to the "magic asterisks" of yore.)
Posted by Menzie Chinn at November 2, 2008 09:44 PMdigg this | reddit
I must have missed the reference to the specified spending reductions from McCain's competitor.
Do you have those figures at hand so that we can examine those spending reductions?
Posted by: Babinich at November 3, 2008 03:34 AM
Outstanding. Thank you for this article.
Posted by: Jim G at November 3, 2008 06:01 AM
You can't analyze an income statement without revenue AND expenses.
You cut deficits and balance budgets with things you can immediately control--expenses. Revenue projections are highly speculative.
What if tax-cuts (revenue reductions) increase taxable income? It is not unheard of--remember the Clinton budget surpluses?
Interesting analysis, but not a complete picture.
Posted by: Bill Rice at November 3, 2008 06:02 AM
Does spending have any impact on the fiscal implications? Have you done any analysis of increased spending versus increased tax revenue? How about projected spending cuts versus tax revenue?
Have you compared the findings of the ultra-liberal Urban Institute/Brookings Institution with more centrist institutions or conservative institutions?
Have you done any analysis of incentive/disincentive per Romer's analysis, dynamic versus static scoring?
The graph in figure 1 states that the line was determined as "Obama tax plan as stated by campaign staff (blue), baseline with McCain plan as stated by campaign staff (red)." Has there been any trend done on the bi-weekly changes Obama has been making to his plans versus the McCain plan for the same periods? Also have the campaign staff plans been compared to what is on their web site?
Your comment, "It strikes me that these tax-based initiatives are ill-suited to countering the impact of recession..." is an understatement since neither plan actually addresses the impact of the recent federal plans to naationalize large segments of the credit market as well as certain industries, auto for example. Also, both plans empower government to take from producers but neither plan empowers private citizens to increase their production. It should be obvious that since the government only receives what it gives from productive citizens that only an increase in the output of productive citizens will pull us out of our economic crisis, yet no plan Obama, McCain, Bush, Congress, Treasury, FED addresses the issue of active citizen production.
Posted by: DickF at November 3, 2008 06:19 AM
Yeah... I think that Obama is going to be starting from current law (Bush tax cuts expire FOR EVERYONE, not just those making $250k, or $200k, or $150k, or $120k) and making his increases from there.
And maybe that will be the case even if McCain wins.
After all, the Democrats have Congress, and are only going to get stronger there.
Why would Obama, Pelosi, and Reed, with a supermajority in the Senate, not just let the Bush tax cuts expire, and put Obama's increases on top of that?
Combine that with a complete and rapid pullout in Iraq, and the Democrats would have plenty of cash to throw at their supporters. An Iraq pullout would give them the cover to just let the Bush cuts expire.
The Democrats could also just sell this as "austerity", a replay of the Rubin years. Without the spending restraint of a Republican Congress, of course.
This has happened before: Bill Clinton's abandonment of middle class tax cuts shortly after his election in '92.
Posted by: Buzzcut at November 3, 2008 06:26 AM
Babinich and Bill Rice: In a previous post, I noted the spending initiatives (not related to stimulus plans) are much harder to score. But if you want a tabulation, see US BudgetWatch's summary here.
Bill Rice: Regarding tax cuts increasing revenues, well, we've had that debate on this blog. See for instance this post, and links contained therein.
Buzzcut: I'm working off current law because that is a standard starting point for tabulating effects, and -- most importantly for me -- allows me to work off CBO projections. You can see impacts working off "current policy" in the referenced Tax Policy Center.
DickF: In answer to your questions: No. No. No. No. No. No. But many of the answers you see can be found in the hyperlinked documents. For analyses from the conservative think tanks, I'll let you check. Regarding centrism, I think you do an injustice to Brookings when you characterize it as ultra-liberal on economic issues. You don't know what you're talking about, or your definition of "ultraliberal" is anything to the left of Cato.
Posted by: Menzie Chinn at November 3, 2008 07:32 AM
I have a slightly off-topic question -- didn't the Fed start to pay intrest on reserves in order to put a lower floor under the effective fed funds rate? (currently 0.75% if I payed attention)
Nonetheless, if we look at http://www.newyorkfed.org/markets/omo/dmm/fedfundsdata.cfm we find that the effective fed funds rate for the last three days is about ~0,3% WAY below target rate of 1%. And even more surprising is the intra-day low of between 0.01 and 0.05 (I assume this happens late in the day when banks are confident they have the liquidity they need at hand) ... I have to admit I am quite puzzled by these numbers: No only does the Fed miss the target big time (that's what they are doing the past 1 1/2 months) -- but the fed funds rate is way below the intrest on reserves.
Prof. Chinn can you solve the puzzle for me (or have any further remarks)?
Thanks and kind regards
Posted by: Maxim at November 3, 2008 09:35 AM
For analyses from the conservative think tanks, I'll let you check.
Naw, they are just about as bad as the liberals. Most, whether right or left, are based on a command economy. Very few actually have plans to empower the people who are the producers.
Posted by: DickF at November 3, 2008 09:40 AM
Excellent preliminary analysis, Menzie.
There will have to be a lot of re-scoring due to the effects of the financial crisis on growth and required spending. But this is the starting point. Purely cet. par., a $4.3 TRILLION difference.
That ain't hay.
Posted by: Charles at November 3, 2008 10:40 AM
Of course that $4.4 TN that is extracted from the private sector will more than be offset by the miraculous effects of the Obama presidency.
Yes we can!
Posted by: Rich Berger at November 3, 2008 11:02 AM
Rich Berger: Thank you for the insightful and constructive comment.
Posted by: Menzie Chinn at November 3, 2008 11:06 AM
You're always the hardest on the one you love...
Posted by: Babinich at November 3, 2008 11:20 AM
Deutche Bank is on cue, no matter who wins. With private domestic saving on the way up, only government borrowing can maintain aggregate demand. The notion that, somehow this won't be trus if (when?) Obama is elected is just being silly.
Posted by: don at November 3, 2008 11:25 AM
Maxim: I'm not sure I have an answer for you. Here is what today's DB Money Market Monitor says:
Fed funds effective remains well below target, suggesting the liquidity provisions by the Fed remain more so in the overnight market.
Which is another way of saying the Fed might be trying to hit the target with some weight, but places greater emphasis on making sure the other money markets are adequately provisioned in terms of funding. You can see how little the Fed has been hitting target by looking at the relevant graph at the St. Louis Fed's FREDII site, here.
Posted by: Menzie Chinn at November 3, 2008 11:28 AM
don: While I agree the deficit will rise regardless of who is in charge, the question is how much more. I think that is a relevant question, and relates directly to who will make bigger tax cuts and who will promote more spending, Deutsche Bank's best guesses notwithstanding.
Posted by: Menzie Chinn at November 3, 2008 11:31 AM
Professor, this is all fine and good and logical.
But, the elephant sitting in the corner is, 'How quickly will the Chinese, Japanese, and sheikhs tire of buying our U.S. Treasuries?'
George Bush and the since departed Republican Congress have taught me not to trust what politicians say. Obama is saving his REAL plans for post-election.
But, honestly, who thinks the Chinese, Japanese, and sheikhs are going to fund our $2 trillion '09 deficit?
Easy money for the U.S. government will be ending very, very soon.
Posted by: jg at November 3, 2008 12:17 PM
So we're saying it's better for the government to siphon off an extra $4.3t over the next decade than not?
Posted by: BK at November 3, 2008 12:30 PM
jg: I don't disagree with your main point that easy money will soon get less easy. This is the point of my posts on the portfolio balance model: , , . That is why it was such a tragedy that the Bush Administration embarked upon the orgy of fiscal profligacy in its 2001 and 2003 tax cuts .
Posted by: Menzie Chinn at November 3, 2008 12:35 PM
This analysis is more detailed in some ways than that completed by myself at www.stocktradingcards.com/blog/ . I tried to make assumptions based upon trying to make Obama's plans to raise spending and cut defense spending work tied in with efficiency savings every politican promises but rarely delivers. Would appreciate comments.
Posted by: Robert NYC at November 3, 2008 12:39 PM
The William Jefferson presidency is probably Obama's blueprint. Pay-go, defense cuts. I figure corporate welfare will also be heavily slashed.
Obama is also using tax hikes for the "rich" and tax cuts for the "middle class" mumble as Clinton. In the end, Clinton couldn't deliver the latter in 1993.
Obama is willing to deal with the economic weakness those cuts will bring if growth gets going later like William Jeffersons term pushing investment foward. It almost triggered a recession in 1995 but helped spur the late 90's boom to historic longevity(4 years), we are already in recession now so more cover.
Posted by: Sandman at November 3, 2008 01:11 PM
I was simply trying to point out humorously (sarcastically) that focusing on the Fed balance sheet ignores the destructive effects on the taxpayers. They no longer have the money to spend or invest and the additional taxes are a disincentive to work and an incentive to seek tax shelters. Economics is supposed to be an antidote to those who see only the good effects of a policy and ignore the harmful effects.
Until the credit crisis, in spite of the Bush admin's profligacy, the deficit was shrinking, in spite of the tax cuts.
My prediction, if Obama is elected, and if his tax ideas are put into effect, tax receipts will be significantly lower than expected as will economic growth. As Bob Brinker has pointed out, with the elimination of the cap on SS taxes, the increase in the top Federal bracket to 39.6% and state taxes, the self-employed in high tax states like CA, NY and NJ will be looking at marginal rates in the low 60%'s. Anyone interested in working for 38 cents on the dollar?
Posted by: Rich Berger at November 3, 2008 01:13 PM
Rich Berger: Apologies for not seeing the humor.
I agree taxes have deleterious effects; so too do deficits run when the economy is at full employment. And spending has benefits, as well. That's why costs need to be weighed against benefits -- so we're in agreement.
However, I take issue with your statement: "Until the credit crisis, in spite of the Bush admin's profligacy, the deficit was shrinking, in spite of the tax cuts." Look at Figure 1 in this post from nearly a year ago and you can see the Federal budget balance to GDP ratio was already declining then.
Who is Bob Brinker?
Posted by: Menzie Chinn at November 3, 2008 01:35 PM
I believe the current administration squandered the opportunity to make spending cuts during the boom from 2004-07. Had they made that, it would have slowed down the economy and spending and would have made the current fall less painful. Also that would have reduced national debt giving the next administration plenty of room to proceed with their fiscal policy. But, we cannot go back in time :(.
So, here is an alternate proposal:
Posted by: EconJournal at November 3, 2008 10:42 PM
Bob Brinker has a financial show on the weekends (Money Talk). He was doing simple arithmetic to point out the punitive effect of anticipated taxes under Obama.
I believe that taxes and government spending is a large net loser. For one, higher taxes reduce effort. Second, spending directed by politicians is inefficient, directed to ends that were not valued enough to be funded privately. There are no "results" that are evaluated after the fact to determine whether the spending was effective.
Finally, increased taxes and increased government spending mean less liberty. The loss of liberty is the most harmful expected effect of an Obama administration.
Posted by: Rich Berger at November 4, 2008 05:26 AM
I'm less concerned with how much the deficit will rise than how much spending rises and how much interest on debt rises. If interest is low, borrow damn it.
Posted by: aaron at November 4, 2008 07:05 AM
(Especially right now, I believe interest is far lower than the deadweight loss of transfers.)
Posted by: aaron at November 4, 2008 07:13 AM
Rich Berger: Then there are no externalities, and the national highway system would have been built privately in the absence of Federal intervention? I see your point, but there is a substantial academic literature on infrastructure spending spillovers, as well as R&D spending (remember the USDA experimental stations...). On the point that we need to make sure the spending is effective, in the short run in raising aggregate demand (when in a recession), or in the long run in boosting potential GDP.
Regarding tax rates, well, think about this -- how many corporations pay the statutory marginal rate?
Last point: regarding work effort, I think it worthwhile to remember basic micro, that at the individual level, income and price effects offset. That's why at some initial tax rates, for some groups, the quantitative impact of higher marginal rates is small.
aaron: Not that I'm disagreeing, but isn't borrowing at low interest rates when higher interest rates might come down the pike the way in which we (or a lot of people with mortgages) got into trouble? See also The credit card bill comes due (international version).
Posted by: Menzie Chinn at November 4, 2008 08:24 AM
Federal revenue will go up less under McCain then Obama? Thanks. That is all I need to know before casting my ballot.
But then, I am one of those anarchist types that care more about my personal revenue than that of the federal government.
Resistance is NOT futile.
Posted by: Hitchhiker at November 4, 2008 08:55 AM
Yes, I think it's just a matter of not overdoing it and being able to tighten your belt and pay down pricipal when rates do begin to rise (I think this would be much easier with less increses in spending commitments).
We also need to consider what made interest rates go up. It wasn't simply that people decided we borrowed too much and marginally increased for more borrowing, it was that default risk shifted. Peoples and businesses incomes didn't increase along with expenses. For the broader government, it's pretty much a matter of whether better investments are availible, we just need to remain competitive (that means less spending commitment and better spending). It'll be much easier to pay down debt if we don't commit ourselvess to even more expenditures, and we shouldn't see a sudden upward shift in interest rates unless a new entity with higher returns and less risk appears. We should see incremental inceases in rates that will signal that if we want more spending, to keep interest rates from going up, we need to raise taxes.
Posted by: aaron at November 4, 2008 09:45 AM
I do not believe that there are no benefits to government spending. I believe that on balance, higher taxes and higher government spending is a loss, for the reasons noted above. I do not know if the interstate highway system as it currently exists would have been privately funded - probably not. But a system would have been built and paid for by tolls - as far as I know it is not legal to build private toll roads.
I don't know how many corporations pay the statutory marginal tax rate, but I'll be that they pay close to the marginal rate on the next $1 of earnings. I would ditch the corporate tax rate anyway.
Posted by: Rich Berger at November 4, 2008 10:03 AM
On the lighter side, here's a Phototoon to memorialize the moment.
Posted by: Charles at November 4, 2008 04:40 PM
Here's hoping this blog is remotely as critical of economic policy over the next four years as it has been in the past, but in reality I'm expecting it to go along with half the country in shifting from a negative spin to a positive one on all news. (While the other half shifts the opposite way.)
Posted by: MM at November 5, 2008 07:59 AM
MM: If the policy stance has been as hideously terrible as it has been over the past seven and half years, then it will almost be impossible not to have a more positive assessment of economic policymaking, even if it is not "spin". To be balanced is not the same as criticizing a bad policy and good policy equally.
Posted by: Menzie Chinn at November 5, 2008 10:35 AM
I think you are underestimating our new Democrat overlords. Sort of reminds me of these lines from Caddyshack-
Judge Smails: You know, you should play with Dr. Beeper and myself. I mean, he's been club champion for three years running and I'm no slouch myself.
Ty Webb: Don't sell yourself short Judge, you're a tremendous slouch.
I'll take my pain with a dash of humor though. I'm sure that Nancy and Harry and Barry will have some interesting interactions, when reality collides with empty promises.
Posted by: Rich Berger at November 5, 2008 11:53 AM
Rich Berger: Sorry, I don't get the humor -- having never seen Caddyshack. You'll have to stick to "Dirty Harry" movies for me to get the allusions.
Posted by: Menzie Chinn at November 5, 2008 01:31 PM
Fair enough, Professor. I like those movies, too, even though they appeal to one's violent nature. Good clean fun.
Posted by: Rich Berger at November 5, 2008 01:42 PM
Menzie, you can't know joy until you've seen Caddyshack.
Posted by: aaron at November 10, 2008 10:38 AM
Following an historic election, let's take a moment to examine just what an Obama presidency will mean to the United States - what we have to look forward to, and how he will deal with our current economic issues. According Jim Davidson, some of the numbers just don't add up:
"One of Obama's specific proposals is to raise the capital gains and dividend taxes to 25%, which will sharply increase capital confiscation as increasing percentages of "gains" will reflect inflationary depreciation of the currency. In the U.S., an investor must pay tax on the difference between the sales price of an asset and it purchase price, with no adjustment for inflation. Consequently, when the tax rate and inflation are high, a large portion of the "capital gain" is illusory. Any asset that appreciates by less than the rate of inflation will result in its owner losing purchasing power and having to pay taxes on the illusory gains. At Obama's higher tax rates, (he has suggested that capital gains and dividend taxes should be hiked to as much as 25%,) capital confiscation would result from modest levels of inflation.
And the Great Credit Crunch implies that inflation will be far higher than in recent experience.
Setting aside whether it is moral or equitable to force a small fraction of the population to essentially pay for the whole cost of government, much of which entails the shuffling of checks to purchase votes of various aggrieved groups, there is a bigger question. Can it be wise for the whole fiscal regime to stand on the shoulders of a small group, like a pyramid tottering on its point, so that any tribulation which undermines the prosperity of those who pay would promise to bankrupt the state?"
Posted by: Contrarian Profits at November 10, 2008 11:10 AM
Contrarian Profits: "...inflation will be far higher than in recent experience." OK, but I'll wait to see that transpire.
You state: "Setting aside whether it is moral or equitable to force a small fraction of the population to essentially pay for the whole cost of government, much of which entails the shuffling of checks to purchase votes of various aggrieved groups, there is a bigger question. Can it be wise for the whole fiscal regime to stand on the shoulders of a small group, like a pyramid tottering on its point, so that any tribulation which undermines the prosperity of those who pay would promise to bankrupt the state?" My response is you're right to worry. Why should we keep on cutting tax rates on the highest income deciles, giving further tax breaks on capital, such that the Republican party can buy votes from those groups? (And when we discuss taxes, we should recall that there are also in addition to income taxes payroll and sales taxes.)
Posted by: Menzie Chinn at November 12, 2008 02:50 PM