Higher Income Taxes Squeeze the Middle Class

Editor’s Note: This is the second of a three-part series on U.S. tax reform. To read part one on corporate tax reform, click here.

President Barack Obama and many Democrats are contemplating allowing the 2001 and 2003 income tax cuts to expire at the end of 2012. Obama has also proposed a millionaire tax hike in several pieces of legislation – a 5.6% surtax on income over that level – which he has nicknamed “the Buffett tax,” after billionaire Warren Buffett.

The arguments being made for such tax rate increases are that it will help close the widening debt and record budget deficit in America, as well as produce more revenue and create more jobs. But a closer look at prior attempts to generate job growth and increase revenues through raising taxes shows that it does not produce the desired results and in fact is counterproductive to these goals. The underlying problem America is suffering from is reckless, irresponsible, and wasteful spending.

Let’s start with the revenue question: Does raising tax rates produce more revenue? While one may think it naturally would, history shows quite the opposite. Internal Revenue Service data shows there were 206 people who reported annual incomes of $1 million or more in 1916. But, as the tax rate on high incomes skyrocketed under the Woodrow Wilson administration, that number plummeted to just 21 people reporting $1 million a year in income five years later.

What happened to all those millionaires? Did they flee the country? Did they all die out?

No, actually once the Calvin Coolidge administration started cutting tax rates on high incomes, there were suddenly 207 more people reporting taxable incomes of $1 million or more by 1925. The government, which collected less than $50 million in taxes on capital gains in 1924, suddenly collected more than $100 million in capital gains taxes in 1925.

Most interesting of all, those in the highest income brackets paid 30% of all taxes in 1920 and 65% of all taxes by 1929, after “tax cuts for the rich.” How can that be? Because high tax rates on paper, which many people avoid, often do not bring in as much tax revenue as lower tax rates that more people actually pay after it is safe to come out of tax shelters and report higher rates of taxable income.

This cycle has played itself out time and time again whenever calls for taxing the rich lead to income tax hikes. To give you a contemporary example, we’re seeing the same thing play out in Britain this year. In 2010, Britain decided to raise its top tax rates all the way to 50%. The first revenue returns came in for the government earlier this year, and the revenues have plunged. Not quite the desired effect.

The truth of the matter is the highest tax bracket income earners, when compared with those people in lower tax brackets, are far more capable of changing their taxable income by hiring attorneys, accountants, deferred income specialists, and the like. They can change the location, timing, composition, and volume of income to avoid taxation. Raising taxes only pushes more money and jobs overseas, which leaves America worse off overall.

If you need more evidence of the counterproductive results tax hikes produce, take a look at my home states of Illinois. In January of 2011, Democrat lawmakers passed a 67% income tax hike and 45% corporate tax hike to help close our debt and deficit. Data from the Bureau of Labor Statistics shows that Illinois was creating more jobs every month as the national economy began to recover. However, since the tax hikes were enacted, the state has led the nation in job losses with over 100,000 now, pushing our unemployment rate to over 10%. Worst of all, our levels of spending are so high, it didn’t even put a dent in our debt and deficit.

Which brings us to the second part of the argument: Will tax rate increases help close our widening debt and deficit? I wrote a piece three months ago detailing how our spending has gotten so out-of-control in Washington, it’s impossible to raise taxes high enough or fast enough to keep up with it. Even if we collected all the tax money sitting on the side in corporate cash coffers and hiding overseas today, it would only be enough to pay down either 15.1% of our national debt or 61.5% of the 2012 federal budget. This illustrates once again how raising taxes to keep up with out-of-control spending is not the answer. Spending reform must come first.

Finally, will increasing income tax rates create jobs? Obama unveiled his $447 billion jobs bill back in September, which he claimed would create 1.9 million jobs, and proposed to pay for it by passing the millionaire tax. Bloomberg surveyed 34 economists to gauge the impact of the president’s jobs bill. Of those, 28 economists estimated how many jobs would be created by the bill. The median estimate was 275,000 jobs in 2012 and 13,000 jobs in 2013 for a total of 288,000 jobs — far fewer than the nearly 2 million claimed by the president. That adds up to about $1.55 million worth of taxpayer money for every potential job it would create to lower the unemployment by a mere 0.2%.

The bottom line is there is no substitute for creating jobs, including government, than a robust private sector. Nothing encourages private sector growth, expansion, investment, and job creation faster than certainty, which is produced by fostering a stable, predictable, business-friendly environment that employers and business owners can plan ahead in. Raising tax rates is counterproductive toward this end. It only pushes jobs and money overseas, incentivizes the rich to hide more money from the IRS, and ends up hurting middle class Americans more than anyone else. The 2001 and 2003 tax cuts must stay in effect beyond 2012.

We will explore capital gains tax reform in the third part of this series next week.

Photo Credit: Wikimedia Commons