This surprises me. Even assuming an Obama victory, I would put the probability much lower. As an economic matter, raising anyone's taxes with the economy so weak seems ill-advised. As a political matter, why not just let the Bush tax cuts expire at the end of 2010? Obama could then claim in four years that he never signed a tax hike.
It seems neither economically nor politically sensible for the new President to push for an immediate tax increase, even if an eventual tax increase is his goal. How then to explain the betting at Intrade? I can think of three hypotheses:
The Obama people are not as savvy as I think they are and will push for an immediate tax hike.
The Intrade market is so thin that the pricing there does not mean much.
Some people are using the Intrade market as a hedge. A high-income person bets that tax rates will go up and bids up the implied probability above the true probability. If the bet pays off, his winnings reduce some of the hit his after-tax income takes by the tax change. It is a form of insurance. Those traders on the other side of this bet--who win if taxes do not rise--are buying a high-risk asset, as measured by covariance with their consumption. They need to be compensated for taking this risk. Under this hypothesis, the Intrade price is not a good gauge of the actual probability but includes a substantial risk premium.
Reported by Paul L. Caron
