Taxing the Wealthy

President Obama's proposal to impose higher taxes on those earning more than $1 million each year (which would certainly qualify as "wealthy" by anyone's definition) in order to insure that the wealthy pay at least the same rate of tax as middle income Americans, has produced the usual claims that higher taxes on the wealthy will hurt economic growth.

Claims which are absolute nonsense (to put it politely).

Economic growth generally comes from increasing demand for goods and services, and demand comes from four areas:

1. Domestic consumer spending (including housing);
2. Investments by businesses in plant and equipment;
3. Exports (i.e., sales to other countries); and
4. Government spending on goods and services.

Increasing taxes on the wealthy would have no effect on exports, and would allow more spending by the government (which is expansionary), so increasing taxes on high-income Americans would reduce only the first and second types of demand, if its going to reduce anything.

Almost by definition, wealthy people earn more than they spend on themselves. Someone who earns $1 million each year is not going to be spending that $1 million, but is going to be saving or reinvesting most of it. So increasing taxes on the wealthy is not going to reduce consumer spending.

Increasing taxes on the wealthy might affect business investments, because wealthy people who invest in stocks and corporate bonds help those businesses raise capital for investments in new plant and equipment. But that's not what's happening right now.

• Because demand is down, businesses currently have excess capacity, meaning that they have plants and equipment that they are not using to full capacity and have no need to invest in more.
• As a result, businesses are currently holding hundreds of billions of dollars of uninvested cash.
• Because businesses don't need cash to invest and aren't looking for capital or loans, investors are putting their money into federal securities, which is driving interest rates on federal securities down to record lows. (At the August 31 auction of inflation-protected bonds, four-year bonds actually sold at a negative yield, meaning that investors were willing to pay the United States to hold their money for them as long as they got back money with the same value.)

What that means is that, if you let a wealthy person keep more of their income, they are going to take that money and buy more government securities and not invest the money in the economy.

Right now, the best way to expand the economy is through increased government spending that will put more money in the hands of consumers, and that means tax breaks for middle-income taxpayer and more government spending on construction, which provides more employment.

Which is what President Obama is proposing.

The Upcoming Tax Brawl

There's been some media attention to the strange one-year repeal of the federal estate tax, and a few comments on the failure of Congress to pass an "extenders" bill to prevent a number of tax provisions from expiring at the end of 2009, but I have yet to see any public comment on what will be THE political story of 2010, which is that all of the Bush tax cuts will be expiring at the end of the year and, unless Congress acts, almost every tax-paying American will be paying more in federal income tax next year.

For the wealthiest Americans, allowing the Bush tax cuts to "sunset" will be quite a shock. A family of four with $500,000 of income filing a joint return with no itemized deductions would pay $136,208 in federal income tax in 2010, but will have to pay $158,801 in 2011, a $22,607 increase, unless Congress acts. If that $500,000 of income includes qualified dividend income, which is taxed at the capital gain rate of 15% instead of the maximum rate of 35% on ordinary income, the results are even more dramatic. In 2010, $500,000 of income with $250,000 of qualified dividends would result in $89,201 of federal tax, but in 2011 the tax jumps up to $158,801, an increase of $69,600, or almost 80%, in only one year.

Barack Obama campaigned on the pledge (which he has repeated several times since being elected), that he will not raise taxes for those earning less than $250,000. For a family of four with $250,000 of income, their tax bill is $51,701 under current law, but goes to $59,341 in 2011, a $7,640 increase.

Reducing the family's income reduces the impact, but the impact is still there. For a family earning $50,000, the tax bill would be $2,763 under current law, but jumps to $3,878, more than $1,000 more, in 2010.

Even a family earning as little as $30,000 would be affected. That family would owe $400 in federal income tax in 2010, but if the 10% tax bracket and marriage penalty relief both expire, that family's tax bill more than doubles, going from $400 to $878.

And here is where the Senate will jump into inaction. As we have seen very clearly in the attempt at health care reform, it takes only 41 Republican votes in the Senate (which the Republicans now have with newly-elected Scott Brown seated) to block any attempt to raise income tax rates for the wealthy. But these tax increases are already enacted and will happen if Congress does nothing, and it also takes only 41 Democratic votes in the Senate (or the Democratic majority in the more progressive House) to block any extension of the tax cuts for the wealthy.

So it's going to be like health care, only worse. At least with health care, Republicans paid lip service to the idea of reform and compromise, but when it comes to taxes Republicans are going to even pretend to be interested in negotiating with Democrats. With increasing pressure from "tea partiers" and the extreme right, and facing election battles at the end of 2010, Republicans have no reason to do anything but draw a hard line and insist on making the Bush tax cuts permanent.

And Republicans also have every reason to block anything the Democrats try to enact, because they would really like to go into the 2010 election being able to point to enormous tax increases on working Americans in 2011 and blaming it on the Democrats who control Congress.

So it's going to be bloody. It's going to be a bare-knuckled street brawl with knives and chains, and if the Democrats don't get their act together and enact real tax reform before November, they're going to find themselves down on the ground, bloody, and being kicked in the face.

Taxing Political Expenditures

The Supreme Court's recent decision in Citizens United v. Federal Election Commission severely restricts the ability of Congress to regulate, much less prohibit, the use of corporate money to influence elections, but what about Congress's power to tax that money?

As it is now, corporations cannot claim expenses of attempting to influence elections or legislation as business expense (see Internal Revenue Code section 162(e)). So corporate profits that are spent on electioneering are effectively subject to income tax at the corporate level. The shareholders bear the burden of the tax, but very indirectly.

But what if the expenses of electioneering were considered a form of a dividend?

This is not unprecedented, because there are lots of places in the Internal Revenue Code in which something that looks like one thing is recharacterized as something else. To take just one example, IRC section 7872 says that if a corporation makes an interest-free loan to a shareholder, the loan is recharacterized as an interest-bearing loan at a market rate of interest, with imputed interest payments by the shareholder to the corporation and imputed dividend payments in the same amounts by the corporation to the shareholder. There are also many rulings and court decisions in which officers or shareholders who have used corporate money to pay personal expenses are held to have received either compensation or dividends from the corporation.

So it would not be unreasonable for Congress to say that, if a corporation uses its money to advance the personal political beliefs of the officers or shareholders, that money should be considered to be payments to those officers or shareholders. For most publicly-traded corporations, dividends are not tax-deductible by the corporation, so income paid out as dividends is taxed twice, once at the corporate level and again at the shareholder level.

But the really nasty part is that Congress could offer corporations a choice: If the political expenses are approved by the shareholders, then the expenses could be considered a dividend to those shareholders, but if the political expenses are approved only by the board of directors, then the income falls on the directors alone.

Neither alternative is going to be very appealing to corporations. Getting shareholder approval for political spending could turn shareholder meetings into political battles, and stock prices could suffer if investors decide that they don't want to own a stock that pays a dividend of $10 while the investor has $12 of taxable income. But directors are certainly not going to want to pay personal income tax on what might be millions of dollars of income they never actually received.

Taxing directors or shareholders on the money spent on corporate electioneering might not solve the problem of corporate influence, but it might make it more difficult and more painful.

Squandered

The real Bush legacy (not the one he imagines) can be summed up in one word: Squandered.

At the beginning of Bush's first term, the United States had a balanced budget, moderate debt, healthy and well-equipped armed forces, and a dominant leadership position in the world community. And, after the 9/11 attacks, there was unity within the United States and sympathy from abroad.

What did Bush do with all those assets? He squandered them.

Bush's tax cuts for the wealthy has driven up our national debt to record levels.

The invasion of Iraq and the resulting pressure on our armed forces (while also trying to fight a ground war in Afghanistan) has stretched our military to the breaking point and has depleted so much equipment and morale that it would take years to recover even if the war ended tomorrow.

Our continuing use of violence and threats of violence as a solution to all problems, both on an individual level (Guantanamo Bay, secret prisons, "extraordinary rendition," and the use of what the world considers torture) and a national level (Bush now talks openly of using military power against Iran) has completely negated whatever international goodwill that existed after 9/11, and has undermined our role as a moral and diplomatic world leader.

And, the unity that arose after 9/11 was effectively killed by the realization that we'd been manipulated at best (lied to at worst) in Bush's rush to invade Iraq.

Now we're facing real threats, both in a looming recession and continuing fall in the value of the dollar, and in the rise of the power of the Taliban in Afghanistan and Pakistan, and we've got nothing to fall back on. Bush squandered the economic and military resources we should have kept for emergencies.

The Social Security "Crisis"

We've heard for years about a "crisis" in Social Security, as benefits are predicted to exceed FICA tax revenues at some time in the future, most recently in 2005 as President Bush tried to undermine the Social Security system by allowing workers to opt out of the system and create private accounts (which even the White House eventually agreed would not solve the financial problems of the system). But the assumptions made by the Social Security Administration are conservative and new projections often push the predicted shortfall further into the future. (The latest estimates, in the 2007 reports of the Social Security Administration, say that projected tax income will begin to fall short of outlays in 2017, and the trust fund will be exhausted in 2041.) Now, there are new reasons to believe that the predicted shortfall might never occur.

According to the book "Microtrends" by Mark Penn, a growing number of people are working past the traditional retirement age of 65, either by necessity or choice. For example, the number of workers 65 and older has almost doubled in the last 25 years, and a 2005 survey by Merrill Lynch found that three fourths of baby boomers were not planning a traditional retirement.

Of course, if people work longer, they continue to contribute taxes while delaying receipts of benefits. According to an economist at the Urban Institute, Eugene Steuerle, if everyone worked just one year longer than the SSA has been assuming, and so received one year less in benefits and contributed one more year of FICA taxes, the projected shortfall would disappear.

There is also recent news that the fertility rate for American women has reversed a long-term downward trend, and is now something like 2.1 children per woman, which exceeds the "replacement rate" and is one of the highest of any industrialized nation. That means that in 20 years we may have more workers than previously expected, and more tax revenue than previously predicted.

All of which means that the so-called "crisis" in Social Security might no longer exist (assuming it ever really did exist).

But funding Medicaid and Medicare is going to be a problem.