The Magazine

Obamanomics

How McCain can fight back--if he cares to.

Jun 30, 2008, Vol. 13, No. 40 • By IRWIN M. STELZER
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Every day that passes makes one thing clearer and clearer: Barack Obama knows precisely what he wants to do to the U.S. economy, and John McCain is intent on proving his self-confessed lack of knowledge with a charming set of homilies.

Start with Obama's proposal to raise taxes on all families earning more than $250,000 per year in order to finance a $1,000 tax cut for "middle-income" tax payers. Assuming that there is enough money to be had from taxpayers in that higher-income class to fund the cut for the much larger number of middle-income earners--a heroic assumption--McCain's charge that Obama is planning a massive tax increase doesn't apply to this overt redistribution of the tax burden. Taking from Peter and giving to Paul is not an increase in the taking.

Nor can this rejiggering of the tax burden be dismissed out of hand. The transfer of income from one taxpayer to another does not reduce total welfare. Indeed, the Obama proposal arguably increases welfare or, to use the vaguer but more voguish term, "happiness." Economists, and this includes those working for McCain, know that the value ("marginal utility") of a $1,000 increase in income for someone earning $60,000 per year exceeds the loss in value, even of a greater sum, to someone earning $250,000 and more. So Obama can rightly claim that this one of his several tax proposals does not involve a tax increase, and makes a lot of people much better off at the expense of making a few people only slightly worse off. Not bad policy.

Or is it? McCain's people will undoubtedly work the numbers to see if one can indeed take a chunk from a few Peters and get enough to add a consequential amount to lots of poorer Pauls. But even if the numbers don't support the feasibility of the Obama redistribution, I suspect that point will get lost in the welter of statistical claim and counterclaim. The take-away, as the pros in Washington call it, will be: Obama wants to tax those who have appropriated most of the benefits of the recent prosperity and share those benefits more fairly with those who have been left behind.

No, if McCain is to have an answer it must be based on a demolition of the basic Obama thesis that he can make many people better off by making a few worse off, and a demonstration that the Obama program satisfies neither the criterion of economic efficiency nor the (more potent) public notion of what is fair. It will be necessary for McCain to show that the recipients of Obama's $1,000 gift will not be better off, and might indeed be worse off after the income transfer is completed. How could this be?

Taxes change behavior. By raising rates on upper income payers, Obama is reducing their incentive to work and take risks. The income tax increase is not all that he has in mind for them. He plans to increase their payroll taxes, the taxes they pay on dividends received and capital gains earned, and on any transfers they might have in mind to their kith and kin when they shuffle off this mortal coil. If the aggregate of these additional taxes substantially diminishes incentives to set up a small business of the sort that has created most of the new jobs in recent decades, the $1,000 tax rebate will be more than offset by the consequences of reduced growth and new business formation.

There are two problems with this counterpunch. The first is that we have no idea whether it is true. The McCain campaign has shown little taste for doing the sort of empirical work on which the Obama team thrives. The second is that this is just the sort of exercise that McCain finds unappealing. At best, he will leave such matters to "surrogates." Alas, the precise mechanics by which they will answer questions directed at their candidate during the town hall meetings he is proposing have not been worked out.

Perhaps, then, there is some sort of income redistribution with which McCain can be comfortable, the sort that increases faith in the fairness of the market capitalist system of which he is justifiably so fond, and which has produced greater prosperity for more people than any other economic system.

Surely the populist streak in the Arizona Republican leads him to find something wrong--yes, wrong--with the way executive compensation has become divorced from executive performance. And surely he would be comfortable calling for greater shareholder participation in the approval of executive compensation, and supporting the SEC's recent efforts to require corporations to report just how they plan to relate executive compensation to performance.