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The Fiscal Cliff: Why Sticking It To The Rich Will Hurt Everyone

Thu, Nov 15, 3:12 PM ET, by Bob McTeer

Excuse me investors, but I thought you were aware of the fiscal cliff before the election; but, apparently not. I'm sorry you finally noticed, but glad that you don't approve. Beep! Beep!

The tax debate during the campaign left a lot to be desired—almost everything in fact. The Republicans overstated their case a bit, but the President ignored its fundamental correctness. And he won the election.

Now, given his post-election lines in the sand, he wants to rub that sand in. By golly, we have to have not just tax revenue increases to supplement spending cuts, but tax rate increases as the means to tax revenue increases. In fact, he is doubling up on that point. Never mind, as the loyal opposition argued, that there is very little blood to be squeezed from those turnips earning more than $200,000, or $250,000 if married, even in a static model. And never mind the damage done to a dynamic economy by reducing the earning incentives of "the wealthy." Where are the English teachers to object to defining wealth (a stock) by income (a flow) anyway? The point now is simply who won, and how he is going to stick it to the other side.

I said the Republicans overstated their case a bit, which contributed to their second place finish because their talking points on taxes seemed to defy common sense. I think most voters might agree that most marginal tax rate increases discourage the activity taxed. At the margin, a tax on earning additional income will reduce the total income earned and will reduce the tax take to some extent. Reducing taxes on additional income earned should increase income and the tax on that income to some extent. This sounds like common sense to me.

It doesn't make since, however, to treat all tax changes as having a Laffer-curve effect—where reductions in the rate increase tax revenue and increases in the rate reduce tax revenue. Laffer, himself, doesn't go that far. It depends on the type of tax , the initial level of the rate before the change, the ability of the payer to influence the timing of realization of the tax and so on. Capital gains tax rate reductions have a good record in that regard. I suspect the lowest hanging fruit right now would be the corporate tax rate. A lower rate would bring money back home to be taxed and would tilt the balance more in favor of U.S. activity as opposed to foreign activity.

As for the impact of increasing the earned income tax rate from 35 percent to about 43 percent (including the tax hidden in new health care program) as the President wants to do, I'm certain it would do major damage to the economy, but it probably wouldn't reduce total tax revenue. It would probably increase a tad. But it would still be a bad tradeoff, and a bad idea. My guess is that an increase in the capital gains tax rate from 15 percent to around 20 percent wouldn't do a lot of damage to tax revenue, but I'm not so sure about raising the dividends tax rate from 15 percent to the same 43 percent as the earned income rate. That's a pretty big deal.

This is another thing not explained well in the campaign—that taxes on capital reduce the potential capital to labor ratio, limit labor productivity gains, and thus limit wage gains. Labor should be urging zero taxes on capital gains, dividends, and savings accounts. Not only will that not happen, but the winners of the election will delight in sticking it to the rich folks, ignoring pension funds, etc.

They say, "Don't tax you, don't tax me, tax that fellow behind that tree." There are a lot more of us than there are fellows behind the tree. Former Texas Senator, Phil Gramm used to talk about, usually in connection with Social Security, needing more people pulling the wagon and fewer people riding in it. We may have reached a tipping point where the riders are so numerous and uninformed that they feel comfortable piling in and charging their ride to the pullers. We can't afford to wait for their education by observing what happens to the economy over the next several years. What we need are leaders who understand it and are willing to stop the pandering. We need them in both parties.

 


SDI Glossary: "Capital gain" Definition
SDI Glossary: "Capital gains tax" Definition
This Article's Word Cloud:   Beep   Laffer   Republicans   This   about   activity   additional   before   behind   campaign   capital   case   damage   dividends   doesn   earned   earning   economy   election   extent   fact   from   gains   have   income   increase   increases   labor   limit   mind   more   need   overstated   percent   point   probably   rate   reduce   revenue   sense   should   taxes   than   that   their   there   tree   where   will   would

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