TCS Daily


Is Obama Swiping the Tax Cut Issue?

By Larry Kudlow - November 3, 2008 12:00 AM

Voters seem to think he's the Ronald Reagan tax-cutter of the 2008 election. Wouldn't it be the height of irony if Barack Obama wins this election as the Ronald Reagan tax-cutter? His tax plans are severely flawed and his campaign narrative to support them is all wrong. And yet a recent Rasmussen poll shows that 31 percent of voters believe Obama is the real tax cutter, while only 11 percent choose McCain.

Believe it or not, Obama seems to have swiped the tax-cut issue from the Republican party. How can this be?

Well, for almost two years Obama has talked about cutting taxes for 95 percent of the people. McCain has no such record. And even though McCain has launched a strong Joe the Plumber investor-class tax-cutting surge in the last days of the campaign, it may not be enough to significantly impact Tuesday's voting results.

This is bad news since Obama has some pretty strange views on taxes. Just look at his recent explanation for the decline in third-quarter GDP. He calls it "a direct result of the Bush administration's trickle-down, Wall Street first, Main Street last policies that John McCain has embraced for the last eight years and plans to continue for the next four."

Is Obama really blaming the Bush tax cuts for this recession?

After the bursting of the tech bubble and the 9/11 attacks, George Bush lowered tax rates across-the-board for individuals and investors. For five years the stock market rallied without interruption -- the longest bull market without a correction in post-WWII history -- while the economy expanded for six years, a bit longer than the average post-war recovery cycle.

And Obama wants folks to believe that tax cuts caused this downturn? Not the credit shock? Not the Obama-supported government mandate to sell unaffordable homes to low-income people and the pressure on Fannie and Freddie to securitize these loans? Not the oil shock?

No self-respecting Keynesian would buy into this. Yet Obama was at it again in Monday's Wall Street Journal, saying, "It's not change to come up with a tax plan that doesn't give a penny of relief to more than 100 million middle-class Americans."

Regrettably, not even John McCain has contradicted this. But the facts speak otherwise.

For example, the nonpartisan Tax Foundation says the Bush tax cuts -- which McCain would maintain -- provided substantially more relief than middle-class Clinton-era tax rates: A single earner making $30,000 will pay $2,756 under 2008 Bush tax law compared with $3,157.50 under Clinton tax law (in 1999). That's a larger Bush tax cut by 8.7 percent. A married couple earning $50,000 will pay $4,012 under Bush compared with $5,085 under Clinton. That's a bigger Bush tax cut by 21 percent.

So the facts of a middle-class tax cut are far different from what Obama claims. Obama also says his tax rates will be below those of Ronald Reagan. Wrong. Obama will raise the top rate to 39.6 percent, whereas Reagan left taxpayers with only two brackets of 15 and 28 percent.

Incidentally, the income cap for Social Security and Medicare taxes was about $42,000 when Reagan left office, compared with $104,000 today and the threat that Obama will raise that cap significantly.

It's also worth noting that the Reagan tax-reform bill of 1986 mistakenly allowed the capital-gains tax rate to move up to 28 percent from 20 percent. Many believe this was a significant factor in the stock market crash of 1987.

Similarly, Obama intends to raise the cap-gains tax rate from 15 to at least 20 percent. It's a risky move. Of course, Obama says only rich people will pay the higher cap-gains rate. But the reality is that a cap-gains tax hike will raise the after-tax cost of all capital, which will depress the future value of all equity assets.

McCain has recently proposed a reduction in the capital-gains tax rate from 15 to 7.5 percent. With 100 million-plus investors out there, and nearly two of every three votes in national elections being made by shareholders, this is right on target. Last Friday, McCain told me in an interview that a "low capital-gains tax is probably the greatest incentive for investment that we have in America today."

In the frenetic final hours of the campaign McCain is also talking up his corporate tax cut, which would be a tremendous boost to plunging stock prices since corporate profits are the mother's milk of stocks. Indeed, McCain's overall tax-cut plan is far more powerful than Obama's when it comes to creating jobs and stimulating economic growth. But his marketing effort appears to be too little, too late.

These things do, however, have a way of balancing out: If Obama and the Democrats go on a tax-hiking spree to penalize successful earners and investors, they will pay for it dearly in 2010 and beyond.

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7 Comments

He has always stated that the over effect is a raising of taxes.
It the people who are stupid.

Larry...tax rates are not that significant...
You said "the Reagan tax-reform bill of 1986 mistakenly allowed the capital-gains tax rate to move up to 28 percent from 20 percent. Many believe this was a significant factor in the stock market crash of 1987."

But for certain the current stock market problems are not related to something like this that President Obama has not done yet.

You said "Obama intends to raise the cap-gains tax rate from 15 to at least 20 percent. It's a risky move."

But this is the same 20% that you just said was OK in 1987 and that Reagan should have left alone.

My own sense as a lifelong entrepreneur myself is that higher tax rates on profits are not negative determinants when we decide to make an investment. Instead, the higher the tax rates are...then the more we are able to shelter our earnings by investing...especially with borrowed funds. It is the availability of bank created liquidity that's significant regarding what we invest in any such period...and our marginal cost of capital. With low interest rates a lot of projects would get funded. If the banks would work with us. And that is the underlying problem today. Bankers who will not make loans to small businesses. Taxes on our potential profits are something we worry about down the road...we should be so lucky...when our investments start paying off.

Granted a public company's stock price is hurt by the earnings-after-taxes number. But that impact is in the near term...through P/E or net present value calculations. In the long view I want to expand my income producing operations regardless of how much tax I'll need to pay someday.

The applicable tax rates and any adjustments the government might make to them are a smaller percentage of projected revenues and profits than my market projection allowance for error. It will be up to my CFO to give me the taxable earnings numbers I need to support stock prices. He's great at that or I'd have gotten rid of him. If the stock market wants to see robust sales projections out into future periods then my VP of Sales tells a terrific story. I make him sign his name to those fantasy numbers.

In any case, if I am not expanding my business today then there will be nothing on the Balanch Sheet for the CFO to work with and nothing in the pipeline for my salesmen to sell three years from now. How to manage my tax exposure all the way out there is not a priority question for me.

Only low margin, high volume players and financial institutions are concerned about tax rate shifts. Rapidly growing smaller companies in profitable industries...the kind that improve the GDP, export Made In America goods and hire lots of people are simply not all that concerned about your capital gains taxes. We just don't care. We have real work to do.

There is no Joe the Plumber. That foolishness is a weak Hollywood fiction...and made for TV. Great for the Jerry Springer voters perhaps...but certainly beneath you, Larry. Thanks.

Marginal decision making
"Taxes on our potential profits are something we worry about down the road...we should be so lucky...when our investments start paying off"

So, if taxes go up from 35% (corporate income tax rate) to say, 45%, you saying that you don't care? That it won't impact your decisions (either before or after) at all?

What if it goes up to 55%? Oh, and the banks whose loans you say are more important of a determinant to whether you expand or not DO look at your after-tax income, do they not?

Perhaps you don't care because of the particular specifics to your business. But enough other businesses either care or are on the margin. 'Enough' being defined as enough to impact future capital investment and growth.

It can be complicated to figure all this out. If the government allowed for 100% full depreciation write-offs for all businesses and corporations, that might have more of an incentive impact for many businesses than the actual tax rates on profits derived from such investments, for example.

I'm competing with other players in my industry...
Zyndryl,

You said "if taxes go up from 35% (corporate income tax rate) to say, 45%, you saying that you don't care? That it won't impact your decisions (either before or after) at all? What if it goes up to 55%?"

No. I don't care what the tax rate will be on my profits if I am a privately held company that has no particular reason to show profits. Public companies need to show profits so they can pay dividends. But not me!

In the extreme case that I have gotten so big that I no longer want to continue expanding and reinvesting my excess earnings that would otherwise be taken away by the IRS I can simply start paying myself and my family members more and those are before tax payroll expense dollars.

If my operation is capital equipment (overhead) intense then I am sheltering lots of that money with depreciation on my physical plant. If I am labor intense and big enough already to...as I said, stop growing...then I will set up a manufacturing operation in Asia and capture a margin in an entity that enjoys low taxes. Lots of perfectly routine and legal ways to work this.

You said "the banks whose loans you say are more important of a determinant to whether you expand or not DO look at your after-tax income, do they not?"

No they don't. The banks look at my ability to service the loan and those interest payments are pre-tax dollars. Remember that I have sheltered my business income from your high corporate taxes with borrowed funds...that were not taxable income when I invested them and grew my Balance Sheet...so that the cash and the other assets I purchased with that cash...or receivables that I carried were balanced by the principal debt liability.

Reducing the principal on that outstanding debt is not deductable as a period expense...it is true...therefore that amount would come out of my after tax earnings if I was purposefully deleveraging my Balance Sheet during a period of unusual profitability and flat revenues. But this only means I am improving my debt to equity ratio by paying down my loan instead of with retained earnings and the bank could not care less about my tax burden if I have decided not to expand.

Alternatively, I can repatriate earnings from my low-tax offshore entity as a loan to my US company and pay down the principal on my bank line with those funds. So many ways to work...so little time to explain a lifetime of doing this stuff for a living. Thanks.


In the end I stay away from the taxman...
I work with my own partners and employees, my customers and my suppliers. We have a mutually supportive relationship of trust. All of us. However, the government purposefully establishes and maintains a confrontational dynamic with my corporate entity...doing everything it can by any underhanded means...to take as much of my working capital away as possible. I did not ask for this trouble. Nevertheless, working with the IRS and freely giving them information that they would certainly use against me...this we must never do. They cannot be trusted.

Therefore, we have tax accountants and tax attorneys and we work constantly to minimize our exposure to bureaucrats who are only out to take as much as they can from us. They enjoy this adversarial relationship because they are managed by politicians who are mostly lawyers. Therefore, debate and deception is all they really know how to do...it's how they were trained...it's the only way they know how to behave.

Let them say what they say about tax rates...let them be high...let them be low. What can I do? Not run my company? Not invest in my business? Let them break me? No.

Instead I will carefully not pay them one dollar more than I must...because they always round the pennies up or down...and I fully expect them to do their damnest to steal from me at every opportunity. They assume that I am cheating on my taxes although I never do...excellent defense, by the way. But the IRS plays very dirty. And they have guns.

I am competing with the other players in my industry and we are all operating in the same economic environment together. The sovereign is simply a predatory force of nature to be dealt with by all of us. We cannot really change much about the government in the immediate planning horizon...the 2009 Annual Plan, for example. So we simply try to stay away from those public servants working for the President. Whoever he might be. Doesn't matter. They are not nice people.

Yes!
You go Obama.

No cuts...
He is not going to be able to stop cut taxes, and the elitist illuminati know this, but still went along with it to secure seats in the House and Senate.

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