The Trillion Dollar Fix

by Megan McArdle


Facing the biggest financial crisis of our generation, the Obama administration has certainly been busy. In the first hundred days, the administration has pushed through the largest stimulus package in U.S. history, steered Chrysler and GM toward a managed reorganization, and stress tested our banking system. Treasury Secretary Geithner has floated multiple plans to rebuild Wall Street with a mixture of public and private capital. And if, as many critics have claimed, the administration's proposed packages have not always been harsh enough to put the fear of God into wayward bankers, the administration certainly managed to scare the bejeesus out of them Monday morning with the fighter plane that buzzed Manhattan's financial district.

It's probably no exaggeration to say that Obama's presidency will ultimately stand or fall on its handling of the financial crisis. And at this point, with respect to all the frantic activity, the polls seem to be saying, so far, so good. Even though a recent New York Times/CBS survey suggests that Americans don't expect the country to be out of recession by the end of his first term, Obama's approval ratings are in the mid-sixties.

Of course, Jimmy Carter's early approval ratings hit 70% before beginning their long downward slide. And Bush's ranged as high as 95% after 9/11. As the Wall Street prospectuses all say, past performance is no guarantee of future results.

Still, Obama's performance thus far ought to offer some clue: has he set the stage for economic victory, or defeat? In some sense, for all its exertions, the Obama administration hasn't actually done all that much.

There is, to be sure, the stimulus. It is indeed large, filled with scores of spending plans, alleged to be "temporary." Like the recently discontinued tax on telephone service -- originally enacted to fund the Spanish-American War -- many of these programs will undoubtedly be with us for decades to come. As of now, however, most of the stimulus money remains to be spent.

Yet while the stimulus package will provide some modest boost to aggregate demand, it in no way addresses the central problems the Obama administration faces. The Medicare and Social Security systems are about to start draining the budget, rather than contributing to it. The "stress tests" are starting to tell us what we already knew: Large parts of the banking sector need more capital, which won't be easy to raise in the current economic environment. The recession, and especially the decline of Wall Street, is badly undercutting Federal tax revenues. All of these problems are just revealing themselves. And they will get worse before they get better.

So far, Obama's only proposal for dealing with the funding shortage is a tax increase on high earners, leaving "95% of working families" untouched. But the math doesn't work. In 2006, the latest year for which data are available, the top 5% of families took home a whopping 36% of national taxable income, and paid 20% of that, or around $600 billion, in Federal income tax. But even before the president's ambitious health care plan emerges from the Congressional policy grinder, the CBO estimates that his budget plans to spend an additional $400 billion each year. He's not going to get there with a small, or even a large, tax increase on high earners. For one thing, the share of national income collected by the top 5% has undoubtedly dropped sharply since 2006, because their incomes tend to depend more on capital and business income, and on bonuses, all of which have fallen off. (That's why tax revenues fell off so steeply in 2001.) And work by economists Thomas Piketty and Emmanuel Saez suggests that the deeper the crisis, the longer and deeper the hit to top incomes: the lessening of the gap between rich and poor during the fifties and sixties may in fact have been largely attributable to the deleterious effects of the Great Depression and World War II.

Even if this weren't the case, it's not really feasible to pay for everything simply by doubling taxes on the wealthy -- because federal income taxes aren't the only taxes they pay. Higher incomes are disproportionately concentrated in places with high state and local taxes, like New York City. There's a practical limit to how high a percentage of income you can take from even the wealthiest financier, not least because they have more discretion about how, and whether, they make money, which means that raising taxes above a certain level rapidly starts depressing the amount of income available to tax. Even most European countries don't try to pay for their welfare states just by soaking the rich.

Up until now, Obama has largely done the fun part of governing: promising people free stuff. To be sure, even some of that is fairly unpopular, but the auto bailouts have undoubtedly pleased the UAW more than they have angered the rest of the population, and most of the bank spending has occurred under programs originated in the Bush administration. Now, however, the bill for Obama's central proposals is about to come due. Unless Obama thinks he can borrow something like a trillion dollars a year indefinitely, he is going to have to ask Americans to make sacrifices to pay for the goodies.

And the taxes needed to pay for the new programs are not the only costs he will ask us to bear. Like most as yet unimplemented programs theoretically designed to make the world a better place, a cap-and-trade regime for reducing carbon emissions polls well. But when Americans actually have to start paying more for gas, electricity, and heating oil, they will not be so enthusiastic -- especially if their budgets are still shrinking. And if health care is not to carry a shocking price tag, it will have to achieve some sort of savings through rationing: drug makers simply don't make enough in profits to foot the entire bill through lower pharmaceutical prices. Richard Epstein has argued convincingly that ClintonCare foundered because most American voters have health insurance they are satisfied with. In theory, they support a government health care program--but when they are confronted by the details of how their health care will change, that support evaporates.

Neither Obama's legacy, nor the economy's performance, will be much affected by what has happened in these early days. The real test for both will be how he handles the tough choices ahead.

Comments (8)

"In 2006, the latest year for which data are available, the top 5% of families took home a whopping 36% of national taxable income, and paid 20% of that, or around $600 billion, in Federal income tax. "

I'm not sure if that sentence contradicts what is presented here or not, but it does make me wonder about how it relates to:

http://economix.blogs.nytimes.com/2009/04/08/how-much-americans-actually-pay-in-taxes/

which reads in part:

"The main findings: The overall effective federal tax rate (the ratio of federal taxes to household income) was 20.7 percent in 2006, with the highest quintile of American households paying 25.8 percent of their income in federal taxes."

rick jones |

Up until now, Obama has largely done the fun part of governing: promising people free stuff. To be sure, even some of that is fairly unpopular, but the auto bailouts have undoubtedly pleased the UAW more than they have angered the rest of the population, and most of the bank spending has occurred under programs originated in the Bush administration. Now, however, the bill for Obama's central proposals is about to come due.

Yep, but Obama is going to try to stick a minority of Americans with that bill. Already something like 40% of people pay no federal income tax. This, of course, will result in surging deficits. The question is, does the deficit resonate? Will anger over that be greater than the happiness generated by free government goodies?

forget everything. who is going buy this debt? you are already looking at an horrendous outbreak of inflation when this recovery finally hits. the liquidity in the system is enormous. you think the rest of the world is going to stick with the dollar to finance this economic folly? what fantasy land do people live in? obama claims to want an economy that isn't built on sand. what the? he's building one based on debt. financial reality and the global economy are going splash a huge dose of reality in the democrats face and everyone is going to suffer.

It generally would help if various media would point out who pays what in taxes.

Here's the share of income by quintile.

Bottom 20% Households: 3.4%
Next 20%: 8.6
Middle 20%: 14.5
Next 20%: 22.9
Top 20%: 50.5%

For interest: top 5% earns 22%

Keep in mind that richer households are larger — an average of 3.1 people in the top fifth, compared with 2.5 people in the middle fifth and 1.7 in the bottom fifth. So the smaller household almost by definition will make less - because fewer people are working. Can't have two incomes if there are only 1.7 people....

Now let's look at percentage of taxes paid:
Bottom 20%: 0.8 (all federal) and -2.8 (income - they got $ back)
Next 20%: 4.1 and -0.8 (they also got $ back)
Middle 20%: 9.1 and 4.4
Next 20%: 16.5 and 12.9
Top 20%: 69.3 and 86.3%

This info is from the Census Bureau and the CBO.

No matter how you slice it, the US tax code is steeply progressive, taxes any dollar that a two-income household earns more heavily than a one-income household, penalizes extra effort, and gives back far more to low income households than it takes. And Colin is quite right. 40% of households pay no income tax, and in fact get money back. Nice gig...and it almost guarantees a lasting majority for whichever party does it.

All you folks complaining about taxes should just do what people like Tim Geithner does ... cheat on your taxes.

It's easy, after all. Just make some cash income and don't declare it. Shhhhhh! Timmy won't tell.

Benjamin Franklin once said that a penny saved is a penny earned. But a dollar taxed is only worth 50 cents by the time you pay:

12.5% Social Security
1.8% Health Care Tax
25% Federal Income Tax
6% State Income Tax
5% Sales Tax
5% Property Tax

An untaxed dollar is worth $1.30 ... so do what your Treasury Secretary did for years and years and years: cheat!

movertyperguy |

The wealthy will be moving their money out of the country. Who would be foolish enough to keep large sums of cash in nationalized banks? Equities, the same folks will move those to brokerage accounts overseas for the same reasons. Once the markets settle down a bit watch the money flow out of the country. Don't cry for me Argentina........

As other have commented here, just exactly who is going to buy those bonds? The Chinese are quietly bailing, they are not dumping, they simply aren't buying new debt and slowly cashing out. Communist know a communist when they see one and they don't trust them with their money.

The fun and games will start around late 2011 if there is a mild recovery and there is a bout of inflation. Since any plausible recovery will be weak with high unemployment the Feds can't really soak up liquidity and if they do try to prevent nascent inflation they will bring back another downturn. If they don't stifle nascent inflation they will start an inflationary cycle like that of the seventies. The government will raise taxes as high as they can but with ever diminishing returns as people move the money out of the country or throttle back and earn a bit less. Therefore even lower tax receipts. Unable to raise enough taxes, unable to borrow enough that leaves the circus spectacle of the food fight between the tax parasites on whose ox gets gored.
That or the printing presses will be running full out so we can all sing don't cry for me Argentina..........

Unless Obama thinks he can borrow something like a trillion dollars a year indefinitely, he is going to have to ask Americans to make sacrifices to pay for the goodies.

And if he asks Americans to make sacrifices, those same sacrifices ought to be mirrored by the members of Congress. Rescinding their automatic annual salary increase (and suspending it indefinitely) would be a good opening gesture, followed by a massive decrease in perks, especially private planes. And any health care package passed by Congress should apply to its members as well.

I'm dreaming, you say? These people should not be asking Americans to make any sort of sacrifice that they're not prepared to also make themselves. And they should be thrown out (and their successors term-limited) if they refuse to do so. People talk about there being "two Americas" all the time, and this particular concept of that subject should be ended immediately.

"So far, Obama's only proposal for dealing with the funding shortage is a tax increase on high earners, leaving "95% of working families" untouched. But the math doesn't work. In 2006, the latest year for which data are available, the top 5% of families took home a whopping 36% of national taxable income, and paid 20% of that, or around $600 billion, in Federal income tax."

Obama doesn't need to worry about "leaving 95% of working families untouched", he just needs to pay off 51% of the voting population with freebies paid for by the rest of the voters. FDR did it; unions, farmers, government employees (WPA, etc.) got him elected and re-elected four times. Obama can leave plenty of people steaming mad, but if he's got 51%, there isn't much they are going to be able to do except shut up and pay for all the fun, quit making money or leave the country. Throw in another 10M illegal alien voters he wants to legalize and it will really tip his way. As orthodoc showed, he's already 90% of the way there.

Concerned Citizen |