Will Coddling the Middle Class Kill Obama’s Plans?

by Will Wilkinson on February 27, 2009

Earlier today I was thinking about the same Lane Kenworthy post Matt Yglesias discusses here. The upshot is that if you want to reduce inequality through redistribution, tax progressivity barely helps. You need to take a huge chunk of GDP in taxes in order to finance progressive spending. The more general, sort of obvious point is that if you want to massively increase government spending, the government needs a lot more revenue. But you can take everything from the rich and you still won’t have enough. So you’ve got to massively increase taxation on the middle class. The best way to do this is through a consumption tax. But Obama keeps reinforcing, again and again, that middle-class tax rates won’t rise, as if this is itself a matter of justice. So where’s all the money going to come from to do all these amazing things? Eventually, it’s a huge increase in taxes for the middle class or nothing. This may not be a big political winner.

The progressivity of the American tax system puts big-spending progressives in a bind. They should want a consumption tax with a huge, wide base. The easiest way for government to devour ever-larger chunks of economic output is through the device of a slow series of very small rate increases on a broad base. The smaller the tax base, the more dramatically you have to hike rates in order to significantly increase revenue. But dramatically hiking rates tends to discourage political buy-in from those who must pay. Indeed, it tends to incite heated resistance. Obama did very well with the rich. But that may not last if he hits them as hard as it looks like he’s aiming to. At the very least, pushback from this very powerful bloc of voters will limit his success in raising rates at the top. Perhaps he’s cagily playing a baseline-setting game, and by announcing large increases, he’ll effectively reduce resistance to small ones, which will look good in comparison. But even the large ones leave him massively short. And government spending cannot be debt-financed forever. And he can only inflate so much of it away.

So Yglesias is right (though he doesn’t quite put it this way). Democratic strategists need to be looking at clever ways for the government to take a lot more money away from middle-class families without thereby making the GOP look golden again. Obama’s been behaving as though he’s much less fiscally constrained than he really is. But by catering to the idea that middle-class taxes shouldn’t ever go up, he’s making it even tougher on himself. Unless he’s in the middle of some kind of ten-steps-ahead rope-a-dope wherein reaffirming the middle class’ right to not pay taxes is a way of softening them up to accept huge tax increases, he may be making a mistake. 

Here’s what I initially said about Kenworthy’s post about revenues and inequality, when I was writing for Free Exchange.

  • Paul G. Brown
    Krugman agrees with you. Today:

    "Whatever politicians may say now, there’s probably a value-added tax in our future."

    Given how reliant the US economy is on carbon based energy, I submit that Obama's emissions trading scheme/carbon tax is a slip down this slope.
  • John Thacker
    The emissions trading scheme is clearly in part a way to try to raise that money in a non-transparent manner. Taxing the middle class without them noticing as much. A VAT might be too obvious; so apparently would be a direct carbon tax.

    I'd also expect taxes on business, whether inefficient taxes on capital, or taxes on labor that are applied to businesses but have the same incidence as on labor directly.
  • Cool Cal
    This is a logically tough sell, given the paucity of actual welfare services the middle class really partake of. It remains to be seen, as per my theory (Obama Euphoria Syndrome, perhaps), whether the level of cognitive dissonance Obama supporters have in regards to their support for him versus their principles, is enough to sustain a smile and a spring in their step while he robs them stupid.

    It has always been a particularly peculiar example of the left's schizophrenia that one moment stimulation of consumption is the virtuous course of action, and at the same time, conspicuous consumption and gluttony are vices to be taxed. Certainly at times, a natural contraction in consumption might be necessary for the economy, but that progressives seem to vacillate almost at the speed of light between these two positions suggests a feeble grasp of the economics of aggregate demand in complex systems - or in the worst case scenario, a disingenuous posturing to manipulate the rubes. Or both.
  • Isn't the problem that too much "redistribution" goes back to the middle class?

    Look at our troubles in California. We can't make a budget, but 40% of our state budget goes to k-12k education (another chunk for higher ed). Those things are "good" surely, but they are also taxing the middle class to benefit the middle class. That can't work in any system with non-zero overhead.
  • It seems to me that there are several things that need to be addressed if, as a country, we want government to occupy a larger portion of the economy (not that I agree with that). The European states are able to reduce inequality through transfers, but it comes at a high price to growth. We need to reduce the tax burden on capital/investment for a supply side shock and at the same time impose the VAT or sales tax. The regressive nature of the VAT or sales tax can be corrected through tax credits for lower incomes. You need higher growth to reduce unemployment or we will just end up lowering our overall living standards. There is a plethora of research showing that taxes on capital are less efficient than taxes on consumption. That being the case, a cut in taxes on capital and a concomitant imposition of a VAT or sales tax should produce a higher growth rate which in turn should produce higher revenue for government. I am not advocating eliminating taxes on capital or income, but reducing them to relieve the growth inhibiting behavioral consequences.

    Another thing that gets ignored in the inequality debate is the role of monetary inflation and political corruption. Living in Miami, maybe I have a better view of what causes inequality because I’m so close to Latin America, but it seems obvious that these two factors are correlated with inequality. There is academic research to back that up:

    http://econpapers.repec.org/paper/cprceprdp/347...

    There are others as well, but I don’t have time to dig them up. There is also a correlation between gini coefficient and corruption.

    When I speak of inflation, I use the classic definition of an increase in money supply relative to demand. If one thinks about how inflation of money and credit is distributed, I think it becomes clear that inflation of the money supply is a signficant factor in producing inequality. When new money is created by the Fed or the banking system, it is the wealthy that benefit first from this new money. As it circulates through the system, the price of goods and/or assets rise. By the time it reaches the poor the purchasing power of the new money has diminished.

    Over the last two decades we have seen three asset bubbles. Ask yourself who benefitted most from the internet bubble, the housing bubble and the commodity bubble. The wealthy who funded the venture capital firms who in turn funded the internet companies were obvious beneficiaries of the internet bubble. Poorer people were stuck buying the inflated stocks after they were floated on the market. In the housing bubble, the wealthy or relatively wealthy, already owned real estate which rose in price. In the commodity bubble, the poor got killed by high gasoline and food prices which had a relatively minor impact on the rich.

    If we want to reduce inequality and fund higher levels of social spending we cannot do it without a higher growth rate. Merely adding new taxes, regardless of their efficiency, is not the answer. The answer is to find a balance between consumption taxes and capital and income taxes. Any real answer will also have to address the serial inflations of the Federal Reserve. While a gold standard has many drawbacks, it may be the only way to restrain the inflationary tendencies of a central bank. At a minimum, the Fed should have its mandate reduced to maintaining the purchasing power of the dollar and leave growth management to fiscal policy.
  • Vangel
    Let people keep what they earn and cut the size of government instead. That way each person gets what s/he deserves.
  • Paul G. Brown
    Vangel - may the graces forbid that anyone gets what they truly deserve!
  • Vangel
    But the ancients were right. In the end our character is our destiny and we do get what we deserve as we become what we truly are.
  • John V
    I have one quibble with Kentworthy's post:

    In his second chart, he should taxes as a % of GDP. But isn't this a bit misleading since those other countries mainly do all taxation from the capital whereas we have a lot of tax levying and collecting going on at the state level...and the local level in bigger cities?
  • John V
    Funny, my french was visiting a few weeks ago and we were talking about the stimulus and he laughed and said it won't be long that we'll have a VAT and that we'll screwed like them a with very expensive cost of consumer goods.

    And he's not even a libertarian.
  • John V
    Also, we should remember that that point a few posts ago about homogeneity and small countries with regard to the feasibility of high taxes and a welare state.

    I think Kenworthy takes a lot for granted in his pursuit of lowering inequality for its own sake at the expense of...everything else.
  • AAH
    I am not a college grad, a simple mother of an Autistic Daughter, due to MErcury in Vaccines, So i am sure my opinion means little to nothing, but I hear all the complaining about the upper class having to pay aliitle more in taxes? and I ask myself, how can anyone person be so greedy.. Not to say we should all have equal monies, but hello is it not the middle and lower class that the upper class feed off. so if we don't have money to spend on the things they offer, then in turn will they not hurt,
    So logically would it not be in the best interest of everyone to let up on the poor and middle class. cause personal there is nothing that anyone in the world does that deserves to make the millions upon million upon m illion, all off of Us going to a foot ball game and buying a cap or jersey. or watching that big time film. so If they can take it from us, then its time to give it back a little, just so we don't all starve and lose our homes in this terrible crisis.. I do not dream to be a millionair, I dream of things like peace, harmony, justice, personally I just want to be comfortable in my moderate home with my moderate belongings. And I do stronbgly feel its time we were catered to.. such a shame that the ones who make all the money have to cry like babies. they should come and live in the shoes of one of us during this time, and just maybe they would think a little differnt. I say Yeah Obama, look out for ALL americans, just cause I am not rich does not make me unworthy of nice things. I hope he sticks to what he has said. he is a hero. And noone can take that away.
    And over the next 8 years I know he will show all non- believers, what a little time and care can do for the people of America,
    One more question do these rich jerks grocery shop? do they know that a gallon of milk and 1 loaf of bread is 7.00 - 8.00 dollars, and HELLO minimum wage is just of & people. so if ya'll are so smart, I am sure u can do the math on that. = can't survive..
  • Greg N.
    I think it was the mercury in vaccines bit that really made this comment perfect. It would have been great without that, but a sundae needs a cherry; a cake, icing.
  • D. K. Sherman
    Theres a conundrum in the original post. Righties keep saying that the top 5% pay most of the taxes and yet . . . they are still rich. So they could still pay more! Double Warren Buffett or Mort Zuckerman's taxes and he's still very, very rich. And no one is talking about doubling.

    I am the mother of a 22 year who was diagnosed with leukemia last year and, as I understand it, as things stand will not be able to buy health insurance once she is over 25 and cannot stay on our employer-insurance-family-policy. I think the best pitch for a public option health insurance is: It could happen to you. Like Social Security, Medicare, disability insurance, etc., the public should support a public option to buy health insurance at an affordable rate because it could happen to you or your loved one. My daughter was never sick as a child and we have no family history of leukemia or other cancers. It could happen to anyone. I'm personally on a mission to tell people that they should insist on blood work when they have feel sick enough to go to a doctor because blood work would have picked up my daughter's illness - that something was very, very wrong, not just a cold - 4 days earlier when she first went to the family doctort. The opthalmologist bills will be many times what the bloodwork might have cost. But the main point is it could happen to anyone.
  • D.K. Sherman
    Oops. Should have included that the opthalmologists bills will be for her losing most of her vision for 3 months due to retinal hemorrhaging, which would not have happened if the doctor had run the blood tests and picked up on the leukemia 4 days earlier. Get blood work if you think you are really not feeling well and the doctor seems to be guessing. I've spoken to many people who had the same experience with family doctor's blithely diagnosing a cold and it turned out to be cancer.
  • richcromwell
    I'll address one of your sentiments: The top 5% are still rich, but the purpose of the tax code is not to render people middle-class or poor. More important, raising taxes on the top brackets to levels that are too high creates an incentive to either hide income, cheat on taxes, or reduce income to a lower bracket. That's the flaw with a very progressive tax system, too many are too reliant on too few.
  • D.K.Sherman
    Nothing that Obama has proposed would render rich people middle class. They will still be rich. Obama is not proposing "taking everything from the rich" as Wilkinson says. They will still be rich. Middle class people should not be scared that their taxes will be raised because tax increases on the rich tap out the rich. The tax increases on the rich leave them still-rich.
  • richcromwell
    I simply said the purpose of the tax code is not to render the wealthy middle class, I didn't say Obama's plans will do so. Regardless, the numbers don't add up and the increased spending cannot be indefinitely financed through debt. Decades of research have shown that tax receipts stay pretty flat regardless of tax rates. When politicians target "the rich" to buy votes, the rich simply find new ways to hide their assets and thus avoid paying taxes on them. At some point everyone's taxes, including the middle class, are going up to pay for all this stuff.
  • "Under Obama's budget proposal, a typical family of four making $300,000 a year would see their federal income taxes increase by $1,100, while a similar family making $500,000 would get an $11,300 increase, according to the Deloitte analysis."

    -STEPHEN OHLEMACHER, Associated Press Write
  • richcromwell
    Great. Doesn't change anything I've said.
  • JohnnyL53
    The federal income tax taxes income...not wealth. You can take all of a rich persons income and still leave them wealthy, however, the next year they will have adjusted so there is not as much income to tax. It is called incentive. How much will I be willing to work if I get to keep an ever smaller percentage? At what point do I decide that the extra income is not worth the hours I put into generating it? Am I supposed to work for the love of paying taxes and that warm fuzzy feeling that 50 to 60 % of every extra dollar I earn is going to somebody else? Sounds kinds close to slavery, although a relatively well compensated servitude, but slavery nonetheless when tax consumers see me as selfish because I will decide to work less and therby generate less in taxes.
  • Micha Elyi
    Yessiree, JohnnyL53, and no matter how much Obama and his corrupt tax-cheat cronies smoking stogies in Cabinet meetings cream the rubes with soak-the-rich tongue syrup, you're not going to see a real tax on wealth. That would cut into the equity on the palace Rezko gifted to Obama, the Kennedy family compound, the Biden estate, all the Wyoming land Ted Turner owns, and a whole lot of Learjet liberal trust funds.

    Naah, taxes will remain targeted on incomes in order to keep any of the rest of us down. Plus it makes sure that only the little people pay taxes.
  • JackSheet
    Tax avoidance will be the result of Obama's actions. If people think they're being soaked they will hide the dough. Very simple.

    Fair Tax is the answer but then Congress can't give out favors so unless the people agitate for it it will never happen.

    Fair tax I buy a Ford I pay less than guy who buys Ferrari. Tax something and you get less of it. Should we tax income or consumption? Also capital gains tax should be abolished, that alone would create enough jobs.
  • SK
    You say, "He may be making a mistake." I disagree. For this to be a mistake, Obama would need to be able to experience negative consequences. Our media-entertainment-academic-public elite will not allow that to happen to him. All the AM radio in the world isn't enough to counter that kind of force. Obama has enough political capital to burn on this, because his news media supporters will just keep supplying him with more.
  • Chester White
    "And government spending cannot be debt-financed forever. And he can only inflate so much of it away."

    Don't be so sure.

    $10T in debt with 10% inflation reduces the real debt by $1T a year.

    Lather, rinse, repeat.
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