Feldstein: The coming tax regime that will kill American productivity

Martin Feldstein doesn’t exactly sugar-coat this peek into a bleak future of high unemployment, loss of American competitiveness, and essentially all the worst parts of the 1970s and 1930s in American economics.  The former Reagan advisor and now Harvard professor says that Barack Obama has learned all the wrong lessons from history.  While Obama’s tax cuts are mainly illusory, the tax hikes are very real, and will kill any hope of a recovery this year, and perhaps ever:

Mr. Obama’s biggest proposed tax increase is the cap-and-trade system of requiring businesses to buy carbon dioxide emission permits. The nonpartisan Congressional Budget Office (CBO) estimates that the proposed permit auctions would raise about $80 billion a year and that these extra taxes would be passed along in higher prices to consumers. Anyone who drives a car, uses public transportation, consumes electricity or buys any product that involves creating CO2 in its production would face higher prices.

CBO Director Douglas Elmendorf testified before the Senate Finance Committee on May 7 that the cap-and-trade price increases resulting from a 15% cut in CO2 emissions would cost the average household roughly $1,600 a year, ranging from $700 in the lowest-income quintile to $2,200 in the highest-income quintile. Since the amount of cap-and-trade tax rises with income, the cap-and-trade tax has the same kind of adverse work incentives as the income tax. And since the purpose of the cap-and-trade plan is to discourage the consumption of CO2-intensive products, energy or means of transportation by raising their cost to consumers, the consumer-price increases would be the same for a 15% reduction in C02 even if the government decides to give away some of the CO2 emissions permits. …

The next-largest tax increase — with a projected rise in revenue of more than $300 billion between 2011 and 2019 — comes from increasing the tax rates on the very small number of taxpayers with incomes over $250,000. Because this revenue estimate doesn’t take into account the extent to which the higher marginal tax rates would cause those taxpayers to reduce their taxable incomes — by changing the way they are compensated, increasing deductible expenditures, or simply earning less — it overstates the resulting increase in revenue.

This is a recurring theme with Obama and tax policy.  He and his advisors use static analysis to predict results from tax increase, ignoring the effect that tax changes have on revenue.  He assumes that a 7% increase in the capital-gains tax, to use one example, will result in a 7% increase in revenue from the previous year, but that’s simply not the case.  The tax hike will cause people to change behaviors to avoid paying higher taxes, either by cashing out this year (resulting in a loss of capital to the marketplace) or not selling off stakes in companies and investing the profit elsewhere.  The effect of the change will itself limit revenues, probably more than the increased percentage will capture, making the policy a net loss to the government.

Dynamic analysis predicts the behavior of the market in response to these changes, and usually provides a much more sound basis for analysis.  It’s why, in the above example, that capital-gains rate cuts usually provide a boost in revenue, as investors gain confidence in the market and assume more risk.  They are less likely to shelter income at the lower rates, or defer profit-taking, allowing for more opportunity for the government to realize revenue.

Nowhere is this deficiency more apparent than with the next tax Feldstein discusses:

The third major tax increase is the plan to raise $220 billion over the next nine years by changing the taxation of foreign-source income. While some extra revenue could no doubt come from ending the tax avoidance gimmicks that use dummy corporations in the Caribbean, most of the projected revenue comes from disallowing corporations to pay lower tax rates on their earnings in countries like Germany, Britain and Ireland. The purpose of the tax change is not just to raise revenue but also to shift overseas production by American firms back to the U.S. by reducing the tax advantage of earning profits abroad.

The administration is likely to be disappointed about its ability to achieve both goals. Bringing production back to be taxed at the higher U.S. tax rate would raise the cost of capital and make the products less competitive in global markets. American corporations would therefore have an incentive to sell their overseas subsidiaries to foreign firms. That would leave future profits overseas, denying the Treasury Department any claim on the resulting tax revenue. And new foreign owners would be more likely to use overseas suppliers than to rely on inputs from the U.S. The net result would be less revenue to the Treasury and fewer jobs in America.

Earlier, I described this policy as Obama’s Smoot-Hawley, and Feldstein explains why in these two paragraphs.  If Obama seriously wanted to create more jobs and more opportunities here in the US with this effort, he would pair it with a dramatic cut in the corporate tax rate, currently second-highest in the developed world at 35%.  Instead, he’s forcing the US to carry a tax burden found nearly nowhere else in the global marketplace, ensuring a lack of competitiveness and higher prices for consumers of American products everywhere around the world, including here.

Obamanomics is a disaster, and it couldn’t come at a worse time.  Four years ago, the country may have been resilient enough to shake off the worst effects of Obama’s policies, but with our economy already reeling, his taxes will kill any chance at recovery.  We will spend years running up massive deficits — which will prompt Obama to impose higher and broader taxes.  Get ready for one of the most vicious of all vicious cycles.