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Intrade: Not a Tax Crystal Ball

2 min readBy: Josh Barro

Greg Mankiw made a post yesterday examining the likelihood that the Bush taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. cuts for high income earners (those in the top two tax brackets) will expire even if John McCain wins the presidential election. Mankiw looked at auction results from Intrade showing an 87% chance that the top income tax rate will exceed 38% in 2011, and a 47% chance that McCain will win the election. Under the assumption that the tax cuts will definitely expire if Obama wins, Mankiw estimates that a McCain administration would be 74% likely to see the Bush tax cuts expire. However, I’d caution against putting stock in this finding.

Political junkies love Intrade because it provides real-time forecasts of election results that should theoretically be free of the problems that plague opinion polls, such as sampling error and systematic biases like “convention bounces.” As promoters of markets, we at the Tax Foundation follow Intrade with particular interest. However, futures markets only work well under certain conditions. One condition is that the market have active participants who trade with each other continually to reflect current information. Another is that the market be deep enough to merit informed traders’ attention– if you can only make a handful of dollars by being an informed participant, there’s no reason to waste your time trading.

Unfortunately, the Intrade auction on 2011 tax rates does not meet these conditions. As of this morning, when Mankiw took the 87% reading, the auction had only seen $110 worth of trading over its lifetime. (By contrast, the “McCain to be elected” auction has had nearly $5 million in activity). This is typical of political auctions on Intrade; except for the Presidential horserace, most available auctions see exceedingly thin trading. Further, the most recent trade, which established the price of 87, was in early August. As such, I think the “evidence” from this auction deserves little weight.

That said, it is true that McCain won’t necessarily extend the Bush tax cuts, even if he wants to. Because of Senate rules that make temporary tax changes easier to approve than permanent ones, the tax cuts approved in 2001 extend only through calendar year 2010, with rates for 2011 scheduled to revert to 1990s levels. Extending the cuts would require congressional approval, and since Congress will almost surely remain in Democratic hands for the next two years, such approval may not be forthcoming.* However, we can’t settle on a specific probability estimate based on Intrade data.

*A more cynical person than I might suggest that McCain felt free to drop his opposition to extending the tax cuts once he realized they would expire with or without his help.