The Effect of the Wrongheaded Obama Tax Increase

Chris Edwards, the Cato Institute Director of Tax Policy Studies, testified before the Senate Committee on Finance on 23 February 2010 on the effects of the proposed Obama tax policy of increasing the top two personal income tax brackets.  Key background facts are:

• The top two personal income tax marginal tax rates are now 35% and 33%.
• The Tax Reform Act of 1986 had reduced the tax rates to either 15% or 28%, but these were increased in the 1990s with a 1993 increase in the top rate to 39.6% and only partially rolled back in the 2000s to the current rate structure.
• More than half of all business income in the United States is reported on individual returns.
• About one-quarter of all individual tax filers earning more than 50% of their income from a business fall into the top two marginal tax rate brackets.  This is about 600,000 businessmen.
• The average of the highest marginal tax rates (combined to include local taxes) of the 30 countries of the OECD has fallen and now matches that of the U.S.
• One-quarter of all U.S. technology companies started in the last 10 years had an immigrant founder.

The consequences of the proposed Obama high tax bracket tax rate increases are:

• Reported income of affected tax payers will fall by 3%.  This wipes out about 40% of the expected tax revenue gain if one ignores behavior changes due to the higher rates.
• The 1993 increase in the top rate to 39.6%, reduced the number of upper middle income households starting a business by as much as 20%.
• A Small Business Administration study found that a 1% decrease in the marginal tax rate would increase entrepreneurial activity by 1.42% for single filers and by 2.0% for married filers.
• Businessmen affected by the highest marginal tax rate will reduce hiring by about 8.5%.
• Business income in those businesses affected by the highest marginal tax rate will drop by 5.7%.
• Capital expenditures of the businesses affected by the highest new tax rate will drop by 9.2%.
• U. S. businesses will find it harder to compete in the global marketplace with the highest corporate tax rate (shared with Japan) and one of the higher highest marginal tax rates.
• Fewer high-skill and highly motivated immigrants will come to the U.S.
• The quarter of high technology businesses founded by immigrants will decrease to a smaller fraction.

The net effect of these dynamic responses of real businessmen to being soaked by the Obama government will be lower, not higher, tax revenues in just a few years time.  The only reason to increase these taxes is for a very short term increase in tax revenues and as an example of class warfare.  If equality is more important than everyone's actual well-being, then this is a viable policy.  But, it is not a viable and rational policy if you aim to

• Allow everyone to have higher incomes, though they will not be equal incomes.
• Increase government tax revenues in the longer haul to be better able to cope with the huge unfunded Medicare, Medicaid, and Social Security liabilities as the Baby Boomers retire.
• Encourage people to work longer (past minimal retirement ages) and harder so they will pay more Medicare and Social Security and income tax money and draw less Social Security money from the government.
• Fire up the jobs creation engine that produced many more jobs in the 1990s when the highest marginal tax rates were lower than the 2000s have produced with already higher marginal tax rates.
• Increase U.S. exports.
• Create as many high technology, high-value added businesses as possible with high paying jobs.

As usual, Obama is just as wrongheaded as he can be.  He is either so ignorant of basic economics that he follows insane tax policies, or he values income equality so highly he is happy to see Americans with many fewer jobs and lower incomes, if only the end result is more income equality.  In other words, he must either be ridiculously ignorant or saturated with hateful envy.