Barack Obama’s fiscal policy can be summarized pretty simply: Cut taxes for low- and middle-class Americans, boost spending for education, health care, and alternative energy, and pay for much of it raising taxes on the rich. That’s not the only way he’d finance his ambitious plans, of course—he’d also have to borrow $3 trillion and get some money from ending the war in Iraq—but he hopes to generate nearly $300 billion over the next decade just from rolling back the Bush tax rate cuts on high-bracket taxpayers.

The numbers are quite striking, according to a new TPC analysis of the Obama plan: Middle-income families would see their taxes cut by about $1000 annually or 5 percent, while those in the top 1 percent (with incomes in excess of $600,000), would pay $130,000, or about 2.7% more. And that does not include the likely impact of Obama’s still-vague plan to boost payroll taxes on those earning more than $250,000. That proposal alone could increase taxes on those high earners by an additional $400 billion over 10 years.

Taxing the rich may be a political winner, but it runs the risk of creating some big economic problems. TPC figures Obama could boost the top effective marginal income tax rate to 46 percent, assuming a 2 percent payroll tax increase. In a high-tax jurisdiction such as New York, the combined state, city, and federal rate would top 50 percent. If high-earners have to pay the full Social Security payroll tax, their rates could approach 60 percent.

We’ve seen those rates before—they have been as high as 90 percent-- and we’ve got a pretty good idea what happens. When labor is taxed that much, wealthy people will find a way to turn ordinary income into capital gains and dividends, or to defer income. The result: At these levels, rising rates generate tax avoidance, not more revenue.

John McCain argues that these high rates will hurt small business most, but that claim is shaky. Fewer than 2 percent of taxpayers with business income are in the top bracket. These entrepreneurs may aspire to millionaire-hood, but most will never get there.

Still, Obama’s effort to make the highest income Americans pay for more of government through higher tax rates will not come without a price.

In response to my blog the other day about economists endorsing John McCain’s proposal to create an alternative individual income tax, Winghunter asked a perfectly reasonable question: What would such a scheme do for the economy?

Winghunter was asking about a version proposed earlier this year by Fred Thompson, a plan which mimics one first put out by the House Republican Study Committee. But the idea is essentially the same: Individuals would figure their liability under both the regular income tax and a simplified lower-rate alternative and pay whichever is less.

TPC has concluded that such a Thompson-like tax system would reduce federal tax revenues by an eye-popping $7 trillion over 10 years. But, getting back to Winghunter’s question: What would that do for the economy?

The short answer is nothing good. A conventional lower-rate structure would boost growth, but only if it is financed, either by spending reductions or tax increases. It happens that CBO has just released a report that looks at the economic effects of a much more modest plan—permanently indexing the Alternative Minimum Tax and extending the 2001 and 2003 tax cuts. It estimated that unless these tax cuts are paid for, deficits would reach 5 percent of GDP by mid-century and 18 percent by 2082. Eighteen percent of GDP happens to be about what we collect in total tax revenues each year. Hello Argentina.

In this study, CBO director Peter Orszag says the economic consequences of such a flow of red ink are literally unimaginable. As he put it, “projected deficits would grow to levels well beyond the range for which economic models have been developed.” Diane Rogers over at economistmom.com has a nice take on this.

Of course, some on the Right may try to dismiss Orszag’s analysis since he used to work in the Clinton Administration and at The Brookings Institution—a think tank Winghunter dismisses as “liberal.”

Trouble is, Orszag’s analysis is essentially identical to what CBO was saying 5 years ago, when its director was Doug Holtz-Eakin, a highly-respected conservative economist who is now John McCain’s chief economic adviser. This is what he said about the impact of tax cuts that are not financed:

“Sustained and rising budget deficits would affect the economy by absorbing funds from the nation’s pool of saving and reducing investment in both the domestic capital stock and foreign assets… As a result, the growth of workers’ productivity would gradually slow, real wages would begin to stagnate, and economic growth would tend to taper off. If that situation continued long enough, rising deficits could actually lead to a sustained contraction of the economy.”

So, no problem. All we need to do is find a way to cut $700 billion-a-year from the $3 trillion federal budget. Until we do, it is pretty clear that tax cuts of this magnitude are nothing but bad for growth.

It is a nice object lesson in how a couple of obscure changes in the tax law can save a few people a lot of money. The IRS has reported that the number of those earning $200,000 or more who paid no taxes rose sharply in 2005. More than 7,300 of these worthies avoided U.S. income tax entirely, two-and-a-half times the year before. About 85,000 paid worldwide taxes of less than 10% of their income.    more »

The other day, the House Ways & Means Committee routinely approved dozens and dozens of tax breaks. Hardly anyone even noticed.   more »

To celebrate April 15, TPC director Len Burman argued yesterday on TaxVox that today’s income tax “is not all bad” and that “we could do a lot worse.” Well, it may not be all bad, but it is pretty awful. And while we could do worse, we could also do a lot better.   more »