The CBO bombshell

In the world of public policy, the Congressional Budget Office's recent finding that Obamacare will weaken economic growth and reduce future employment is like an earthquake of magnitude 8. Finally, finally, the CBO has introduced dynamic assumptions into its models of how the economy responds to existing and proposed policies. (Supply siders have been waiting for this moment for decades.) Before, the CBO would assume that a 10% increase in tax rates would translate into a 10% increase in tax revenues. Now and forevermore, we hope, they will calculate how much the higher rate is likely to depress economic activity (e.g., higher marginal tax rates are likely to cause a reduction in the tax base that could offset all or part of the increase in tax rates). The CBO now acknowledges that Obamacare will hurt the economy because it creates incentives for people to work less. The phasing out of Obamacare subsidies will act as a new marginal tax on work, and whenever you raise taxes on some activity, you should expect to see less of it.

We've known about the higher marginal tax rates hidden within Obamacare's complexity for a long time. What's new is that they are now officially acknowledged by the CBO.

The back story of how this sea change came about can be found in a fascinating WSJ interview of Casey Mulligan, "The Economist Who Exposed Obamacare." Clip this story and file it away so you can show your descendants that you were there when the course of public policy and economic history changed for the better.

The chart above (from the Mulligan interview) is one answer to the question "Why has this been the weakest recovery ever?" Average marginal income tax rates have increased by 15% since 2008, from 40% to 46%, and will increase to 47% next year thanks to the ARRA's "stimulus" spending (over 75% of which consisted of income redistribution) and Obamacare. This comes on top of the huge increase in regulatory burdens occasioned by Dodd-Frank and Obamacare.

The average working-age person in the U.S. now faces the prospect of keeping only 54% of any additional income he or she earns. It's no wonder the economy has lost a lot of its vitality. Some workers today even face the harsh reality of keeping less income despite working and earning more (i.e., they will face marginal tax rates in excess of 100%). My own effective marginal tax rate is over 65%, and that is a powerful force that keeps me from working: I have no desire to hand over two-thirds of any additional income I make to the government.

A few excerpts from the interview:

... the CBO ... reported that by 2024 the equivalent of 2.5 million Americans who were otherwise willing and able to work before ObamaCare will work less or not at all as a result of ObamaCare.

Mr. Mulligan's empirical research puts the best estimate of the contraction at 3%.

... "implicit marginal tax rates" in ObamaCare make work less financially valuable for lower-income Americans. Because the insurance subsidies are tied to income and phase out as cash wages rise, some people will have the incentive to remain poorer in order to continue capturing higher benefits.

The good news, from a forward-looking perspective, is that CBO's new method of dynamic scoring will make tax cuts easier. Before, CBO assumed that tax cuts were automatic losers no matter what; now they will assume that tax cuts can help pay for themselves by increasing economic activity. The economy is crying out for tax reform—particularly a reduction in the grievously high corporate income tax rate. So with the relatively low level of the federal deficit these days and CBO's new dynamic scoring methodology, we could see some very positive changes (e.g., lower marginal tax rates for businesses) in the future. And that, in turn, could revitalize the outlook for economic growth.