Whose Tax Policies Are Better for the Economy? Obama or McCain

September 15, 2008

In conversations over the weekend with Bloomberg Television and on ABC's This Week, former Federal Reserve Chairman Alan Greenspan was asked about Sen. McCain's proposed tax cuts. Greenspan said: "I'm not in favor of financing tax cuts with borrowed money."

This begs the question, which candidate's policies are better for the economy, both short-run and long-run?

In the short-run, if Keynesian stimulus policies were to work, Obama's policies on both the tax and spending side would be more likely to grow the economy. Obama is proposing more spending on infrastructure than McCain, and Obama's tax policies that redistribute from high-income households to lower-and-middle-income households would increase consumption due to the fact that lower-income households have higher marginal propensities to consume than high-income households. In other words, if I handed $10 to Joe Blow who makes $20,000 per year, he is more likely to spend that $20 than if I handed that $10 to Bill Gates. (There are other trade-offs to these types of policies that Obama would most likely acknowledge as maximizing short-run GDP without any concern for the costs is not an optimal policy.)

In the long-run, the economic effect of the various fiscal policies of both McCain and Obama depend in large part on what the two do about spending. As Milton Friedman once said, "To spend is to tax." Both Obama and McCain would likely grow the national debt relative to current law baseline. However, Obama's projected deficits are lower than McCain's according to Tax Policy Center estimates. That being said, McCain's tax policies that are highly focused on cutting taxes on capital are more conducive to long-run economic growth (as measured by GDP) than Obama's tax policies. In other words, for every dollar that McCain would grow the deficit under a static score, that tax cut does have a larger economic feedback in the long-run than $1 added to the deficit under Obama's tax policies.

So the answer on long-run growth is that it depends. McCain's tax cuts are better for long-run growth than Obama's (redistribution is primary goal) when one ignores the deficit. But because McCain's tax cuts would grow the deficit larger than Obama's would, it becomes unclear as to who would grow long-run GDP more. That answer would largely depend upon the underlying economic parameters that determine how deficit-financed tax cuts on capital affect long-run economic growth. It also depends upon each candidate's spending policies (both the level and the priorities).

(Note: This assumes GDP is a relevant measure for "the economy." Sen. Obama's proposals tend to be concerned with the distribution of the economic benefits of our society, which are not captured by an aggregate statistic like GDP even though they are indeed part of social welfare.)


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