Skip to content

Questions About the Obama Tax Plan

3 min readBy: Robert Carroll

Today's Wall Street Journal op-ed by Senator Obama's chief economic advisors, Jason Furman and Austan Goolsbee, outlines much of the senator's 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. platform and makes a number of claims that are not completely consistent with the evidence or the facts. Just a few points:

  • Top tax rate: Senator Obama would raise the top individual tax rate back to 39.6 percent, impose an additional 2 to 4 percent tax on earnings for some over the existing Social Security wage cap, and bring back the phase-out of the personal exemption and certain itemized deductions for higher-income taxpayers. When added up, the top effective marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. rises by 12 to 14 percentage points, from 37.9 percent to roughly 48 to 50 percent. "High" is in the eye of the beholder, but these are tax rates not seen since before the Tax Reform Act of 1986.

Note: These calculations work as follows: (1) 37.9 percent equals the current 35 percent top income tax rate plus the current 2.9 percent Medicare tax rate; and (2) 48 to 50 percent equals Obama's 39.6 percent top income tax rate plus the 2.9 percent Medicare tax rate plus his additional 2-to-4 percent hike in the Social Security tax rate plus an additional roughly 4.5 percent for the phase-out of personal exemption and certain itemized deductionItemized deductions allow individuals to subtract designated expenses from their taxable income and can be claimed in lieu of the standard deduction. Itemized deductions include those for state and local taxes, charitable contributions, and mortgage interest. An estimated 13.7 percent of filers itemized in 2019, most being high-income taxpayers. s.

  • The 1993 record: It is always hard to say what would have happened if Bill Clinton had not raised tax rates. But how damaging were the higher tax rates in economic terms? Economic research suggests that the two higher tax rates he passed on wages damaged the economy and shrank the size of the federal tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. , leaving less income exposed to those new rates. As a consequence, the increase in tax rates raised 40 percent less in revenue than some might have thought.
  • Government debt: Both candidates would increase the government debt. According to the Tax Policy Center, Senator Obama's plan would add $3.4 trillion to the government debt over the next ten years. Senator McCain would add roughly $5 trillion.
  • An important clarification: Senator McCain has proposed a very significant change in the tax treatment of health care. He would replace the existing exclusion for employer-based health insurance premiums with a refundable tax creditA refundable tax credit can be used to generate a federal tax refund larger than the amount of tax paid throughout the year. In other words, a refundable tax credit creates the possibility of a negative federal tax liability. An example of a refundable tax credit is the Earned Income Tax Credit (EITC). for health care. This refundable credit would be $5,000 for family coverage and $2,500 for individual coverage. Importantly, and a point not recognized in the op-ed, McCain's health plan would be revenue neutral. It's not a $3.6 trillion tax hike because the existing $3.6 trillion tax subsidy (over ten years) for health care in the tax code today is rechanneled to low- and moderate-income taxpayers through the credit.

People tend to have very different views on proposals that redistribute income from higher income taxpayers to low and moderate income taxpayers, but it would seem that this important health care proposal from McCain actually fits in well with Senator Obama's tax plan, which is so focused on redistributing the tax burden.

  • Nothing new on the estate taxAn estate tax is imposed on the net value of an individual’s taxable estate, after any exclusions or credits, at the time of death. The tax is paid by the estate itself before assets are distributed to heirs. : The Obama plan would still increase the top estate tax rate to 45 percent and set the exemption at $3.5 million per person ($7 million for couples). This third layer of tax on capital income detracts from economic growth. It adds an equivalent of another 5 to 10 percent tax on capital, in addition to the corporate tax and the investor level taxes on capital and dividends.
  • One interesting detail on dividends and capital gains: Senator Obama would set the top tax rates on dividends and capital gains at the same rate, but proposes to increase the top rate to 20 percent. Note that the 20 percent rate is below the 25 percent and 28 percent that have previously been reported.