February 23, 2009

Obama - Tax & Save

It's called the Laffer Curve. It was popularized in the 1980's by Arthur Laffer and it has been proven time and again that it's not some simple ideological diatribe, but rather a realistic economic postulation. The premise is simple - Increasing taxes can in fact decrease government revenue, and lowering taxes can do the reverse. Of course all depending on where on the curve the current marginal tax rate sits.

The reason it's a discussion topic now is because increasing taxes, in the midst of a recession is at a minimum, a dubious proposition.

But Obama has a plan. He knows better than reality. He can swamp the economy with a stimulus created on borrowed or freshly minted money and have a multiplier effect of less than 1.0 and still stimulate the economy and not cause inflationary pressure.

He can provide a stimulus to business by bailing out selected industries while increasing the taxation on industries thereby forestalling the bailout effect. Weird? To say the least. He's working at cross purposes with himself. True, there is a temporal issue with this argument - the stimulus is supposed to be immediate and the deficit reduction (an admirable goal) is supposed to be a by-2012-or-2013 effect. But what if the stimulus hasn't worked by 2010? What if it has overworked and we're into an inflationary period?

There are too many unknowns right now to be proposing such vast and sweeping changes without addressing their interactivity. It's possible the President is so caught up in his own hype about changing Washington that he's just proposing massive changes for the sake of doing so. Or is Obama just looking at a complete scale back in Iraq, Afghanistan and perhaps Homeland Security and looking for the juice from that to curtail the deficit? If that's the case, then he's playing politics which would come as no surprise. In either case, he's taking the American economy, American security and American industry and not just rolling the dice, he's putting everything down on the bet - going all in - with the confidence or misguided notion that there's just no way this can go wrong. Oh yeah?

Let's just look at the tax situation. Here's a simplified explanation of the Laffer curve.

Until such time as evidence dictates otherwise, Tax Increases are likely to decrease taxation revenue for the government. You want proof? This alone does not prove it, because the data doesn't account for too much history, but in relative terms it makes a strong case for the Laffer idea that lowering taxes increases government revenue if you are on the 'overtaxed' side of the curve.

Whether Obama's tax cuts and his proposed tax increases are schizophrenic or not is a moot point. The fact is the Bush tax cuts drove massive revenue. $2.15 trillion in 2005. That it wasn't used to pay down the national debt is a tragedy. That there were still deficits was an unfortunate missed opportunity. But the fact is that Obama's gambit seems like long, long odds. Too long in fact.

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