I normally stay away from politically tinged posts.  Tonight, I’m posting two.

Call it formal recognition that the McCain candidacy is a lost cause, and that Obama is going to take the White House.  Futures on a McCain win are now down to 15.5% on the Iowa markets, even lower on the Intrade markets.  That’s bad for him, and good for everyone afraid of a McCain victory.  Since the Democrats will likely retain Congress, we will have, for the first time since 1992-1993, a full Democratic sweep.

So the topic turns to Obama, and what he’s likely to do in the next four years.  Obama, like Clinton, actually has a wide set of very smart economic advisors.  Unfortunately, they literally cover the spectrum of economic policy, from conservative to liberal perspectives.  Like Clinton, it’s hard to tell ahead of time which direction he’ll lean on once he’s in office.  It’s Robert Reich vs. Robert Rubin all over again.

This opinion piece ran in the WSJ last week, and it got me thinking.

Originally, I thought Obama’s tax plan was quite clever:

• You can’t argue that income disparity hasn’t become extreme in the past decade
• You can’t cut the taxes of most people, because 40% of Americans don’t owe any taxes
• Most people will not accept higher tax rates to fund new entitlements/distributions
• Solution: Effective negative tax rates!  That allows a progressive tax system to extend into the non-taxpayer minority, without having to approve new distributions.

The WSJ article, however, got me thinking about the accounting for all this, and it has some scary implications.  From the article:

The Tax Foundation estimates that under the Obama plan 63 million Americans, or 44% of all tax filers, would have no income tax liability and most of those would get a check from the IRS each year. The Heritage Foundation’s Center for Data Analysis estimates that by 2011, under the Obama plan, an additional 10 million filers would pay zero taxes while cashing checks from the IRS.

The basic idea is that Obama will change a large number of deductions to refundable tax credits.  That means that, effectively, a large minority of Americans will actually be paying negative taxes.

The problem sounds like semantics, but it has accounting implication:

When is a tax credit just a distribution?

Why does it matter?  Well, a tax credit is just treated like a negative tax.  So if I tax one person $1000, and give a tax credit of $200, it’s treated like $800 of tax revenue.

Welfare is treated like an expenditure.  If I tax one person $1000, and give $200 welfare to another, we declare $1000 of tax revenue, and $200 of spending.

Both net to $800, but have very different implications for the size of government and the perception of spending.

By using tax credits, Obama can state, with a straight face, that he isn’t going to raise taxes, he’s just going to redistribute the burden more fairly.  And technically, he’s correct.

However, if you treat tax credits as entitlement spending, then you see that what he actually could do is radically increase the tax burden on the country, but cancel out a large volume of transfer payments from the spending side of the equation.  So it looks like the tax burden has stayed the same.  It looks like spending has not increased.

But really what’s happened is that a whole new set of entitlements and taxes have come into existence, but cancel themselves out where no one can see them.

This may not sound like a big deal to you, but this type of accounting shenanigan looks highly prone to abuse.  Imagine what our debate about Social Security would look like if Social Security checks were positioned as tax credits instead of distributions?  Medicare.  Welfare.

I’m not saying that Obama will abuse this system per se, but it’s a bad accounting precedent, started by the Earned Income Tax Credit.  The CBO and GAO should declare that tax credits are distributions, and shift the accounting accordingly.  That would provide accurate transparency in the system, while still giving the government flexibility to tax & spend as it sees fit.

I’m not eager to see Enron-style accounting on this scale.

Update (10/16/2008): A few people have asked me for a concrete example of the problem here.  Here is an exaggerated one:

Imagine that Obama sets the income tax rate to 100%, and then gives back 80% of the money in tax credits.  By the Obama accounting, the government’s take would only be 20% of GDP.  However, in actually, the government has confiscated 100% of all income, and redistributed 80% of it.  The 100% is the number that truly reflects the government take, not the 20%.