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Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Thursday, December 30, 2010

Posner, Becker Debate Economic Effects of Obama-GOP Tax Act

Richard Posner, The Tax Deal: A Second Stimulus?:

It is nevertheless possible to defend the new Act on two grounds. The first, and I think less important, is that it indicates the possibility of compromise between the Obama Administration and the resurgent, and increasingly conservative and assertive, Republican Party, though compromise will be more difficult come January when the Republicans take control of the House of Representatives and significantly increase their representation in the Senate. Second, and more important, estimates that GDP would grow by at least 3 percent in 2011 were premised on the expectation that the bulk, at least, of the Bush tax cuts would be continued. Given the weakness of the economy, a sudden tax increase in 2011, which would have been the effect of allowing those cuts to expire, could easily have knocked one or two percentage points off the GDP growth rate.  

It would have been better to have just continued the tax breaks and not have cut the payroll tax and extended unemployment benefits. A small, and possibly (though not probably) temporary, tax cut is unlikely to stimulate much spending, and extending unemployment benefits can actually increase unemployment by making unemployed workers more picky in their search for a new job. These provisions of the Act are simply the Democratic quid pro quo for the tax breaks for the wealthy, favored by the Republicans.

Gary Becker, The Tax and Spending Compromise:

Both supporters and opponents of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 usually confuse its short term-stimulus effects on the economy, and its long-term effects on economic growth. I would give it a grade of C+ as a short-term stimulus to the economy, and a grade of B+ for its effects on longer-term growth.

The Act provides for a one-year two-percentage point reduction in employee contributions to social security taxes at an estimated cost in tax revenue of over $100 billion. This will add a significant amount to the budgetary deficit for the year going forward, while providing very little short-term stimulus. Even the most simplistic Keynesian analysis recognizes that a one-year tax reduction will be mainly saved in order to spread out the added consumption from this additional “wealth” of households over more than a single year. In economics terminology, a one-year tax relief would be considered a transitory increase in income rather than a permanent increase. ...

The largest component of this Tax Relief Act is the extension of the Bush-era tax cuts on incomes, dividends, capital gains, and estates. This extension will have some relatively short-term benefits to the economy by stimulating investments and the formation and expansion of small businesses, but the main case for extending these tax cuts is their effects on longer-term economic growth. The growth rate in per capita incomes is determined mainly by the rates of investments in human and physical capital, and by technological progress. Both these drivers of economic growth are in good part in turn determined by tax rates on personal and business incomes.

I view the maintenance of the Bush tax cuts as only the first important move of the American tax code toward a more effective income tax structure. That structure would have a broad-based low rate flat tax on personal incomes, with little, if any, taxation of corporate incomes, and with dividends and capital gains taxed as ordinary income. As the majority report of the recent National Commission on Fiscal Responsibility and Reform proposed, the income base should be greatly broadened by eliminating the deductibility of interest on mortgages, and a variety of other special deductions that result from the political influence of various special interests. ...

A broad-based flat income tax could have a relatively modest tax rate- perhaps about 25%- and still raise as much revenue as the tax structure that would exist if the Bush tax cuts were allow to lapse. A flat consumption tax would be even better than a flat income tax since such a consumption tax would not distort the incentive to save. However, this type of consumption tax is unlikely to be introduced as a substitute for the income tax. It could play a role as a supplement to the income tax if that combination were necessary to prevent a narrow-based progressive income tax system from being imposed.

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Dr. Becker is proposing a revenue neutral (compared to allowing the Bush cuts to expire) flat income tax rate of 25% that fundamentally restructures the income tax regime by eliminating many deductions and adjustments, although he does not say which.

Even though his proposal is revenue neutral, Dr. Becker's proposal would certainly result in some shifting of the income tax burden within income groups. Unfortunately he never reveals this information. It may be because (1) he does not know it, (in which case he should not be proposing radical changes in the tax system when he does not know their full impact). Or it may be that (2) he knows that the re-structuring will result in shifting the tax burden from high income groups to middle and lower income groups,(lower taxes for Dr. Becker, higher taxes for Dr. Becker's secretary) and he wants to hide this fact, for reasons that should be obvious. It may even be (3) that raising the Cap Gains and Dividend tax rates to 25% will result in a shift of the burden to higher income groups.

My own guess is that the second reason is correct, but I am fully prepared to believe the first, if for no other reason then the fact that professional academics live and work in a different universe then the one the rest of live and work in. Ours is called reality. I also suspect that Dr. Becker has not filled out a tax return in several decades and has no real understanding of the details of the tax system, but I admit this is pure conjecture on my part. If it turns out that Dr. Becker is in addition to his other notable accomplishments an expert on taxes and can, for example, discuss in detail the difference in taxation of an S corporation and an LLC, or describe how basis is computed on partnership interests, he will have my full apology.

At any rate, until an analysis of the burden shift in any revenue neutral tax re-structuring is known, no one should take the proposals or the proposer seriously, no matter how many Nobel prizes he or she has been awarded.

Posted by: Sid | Dec 30, 2010 4:28:37 PM

Borrowing from Sid: "I also suspect that Dr. Becker [almost every congressmen] has not filled out a tax return in several decades and has no real understanding of the details of the tax system...."

Regarding taking any tax proposals seriously, I don't think that an analysis of a tax-neutral burdern is that important. It sure isn't important to Obama, who wants higher taxes only on "millionaires and billionaires" (read: middle class families and up) and who wants lower income people to get back even more than they pay in.

Everyone with income should pay some general revenue tax to have a chit in the game. A least a flat consumption tax would accomplish that.

Posted by: Woody | Dec 31, 2010 1:38:12 PM

Sid imposes a requirement on Becker that is rarely imposed on Democrats.

Posted by: JD | Jan 7, 2011 3:48:49 PM