‘It is not a sensible way to run a country to have this magnitude of tax issues left to annual uncertainty,” said Treasury Secretary Tim Geithner earlier this month, and he’s certainly right about that. But at the current moment the single biggest obstacle to more certainty is his boss, President Obama, who still refuses to compromise on the tax increase set to whack the economy in a mere 30 days.
After meeting with Congressional leaders yesterday, Mr. Obama dispatched Mr. Geithner and budget director Jacob Lew to negotiate a deal. Yet the President is still holding out against even a temporary extension of the 2001 and 2003 tax rates. Republicans won 63 House seats running against those tax increases, but Mr. Obama still seems under the spell of the dead enders led by soon-to-be-former House Speaker Nancy Pelosi.
The magnitude of the looming tax increase ought to snap him out of this hypnosis. If the Democrats who still run Capitol Hill for another month fail to act, tens of millions of American households will see their paychecks shrink immediately in the New Year.
OpinionJournal.com Columnist John Fund on the tax debate within the Democratic caucus, and on the fight for key committee chairmanships in the House.
Capital gains and dividend tax rates will climb to 20% and 39.6%, respectively, from 15%, and the top two income tax rates will climb to 38% and 41% (including deduction phaseouts), from 33% and 35%. The typical family with an income between $40,000 and $75,000 a year will pay as much as $2,000 more in 2011, as the 10% tax rate bracket and the $1,000 per child tax credit vanish.
This could have been resolved months ago, except that the White House and Congressional Democrats insist that some taxes must be raised. Mr. Obama wants the lower rates to expire on incomes of $200,000 for individuals and $250,000 for couples. Dozens of Democrats revolted against that in the campaign, so the latest gambit, courtesy of New York Senator Chuck Schumer, would raise that threshold to $1 million.
Republicans shouldn’t be suckered into raising taxes on anyone, especially not on small business job creators. The U.S. corporate tax rate of 39% (a combination of state average and federal rates) is already about 15 percentage points above the international average, and for the first time in a generation the personal rate of 41% would rise above the average of our overseas rivals. That’s all before the 3.8% surtax on investment income arrives in 2013, courtesy of ObamaCare.
Because most nations tax their companies at a business rate lower than the personal rate, the Tax Foundation says the Obama plan would mean that many Subchapter S corporations in the U.S. would pay “virtually the highest tax rates in the world on their business income.” In other words, the after-tax rate of return on investment in the U.S. would fall relative to investing in Europe or Asia. This is an invitation to outsource more jobs. The U.S. should be cutting tax rates to become more competitive, as President Obama’s deficit reduction commission and tax reform advisory panel have recommended.
About half the income taxed above $250,000 is business income, so small businesses get hammered from the Obama plan. Mr. Schumer argues that if the income threshold for higher taxes is raised to $1 million, Republicans will no longer be able to claim that this plan taxes small business income.
Not so. The Small Business Administration classifies a small business as an entity with fewer than 500 employees. The Schumer plan shifts the tax onto larger, more profitable firms from relatively smaller ones. But this still puts jobs at risk. A business with $1 million or $10 million of net income has many times more employees and does a lot more hiring than a business with, say, $60,000 of net income or one that is losing money.
Democrats say a millionaire surtax would raise about $50 billion a year, but don’t count on it.
The Tax Foundation estimates that of tax filers reporting income of more than $1 million a year, about 80% have business income and that more than 60% of millionaire income is either business or investment income. So about two of every three dollars raised would come directly out of business coffers—i.e., from the capital that businesses need to expand their operations.
Democrats say a millionaire surtax would raise about $50 billion a year, but don’t count on it. Millionaires tend to be financially sophisticated and are well equipped to respond to higher rates by finding tax shelters, exploiting loopholes (municipal bonds!) or simply working less. If high tax rates were irrelevant to economic decisions, the soak-the-rich states of New York, New Jersey and California wouldn’t be losing millionaires to better tax climates.
Tax payments by millionaire households more than doubled to $273 billion in 2007 from $132 billion after the tax rates were cut in 2003. The number of tax returns with $1 million or more in annual reported income doubled over that period thanks to the strong economic rebound. Tax payments by millionaires also increased dramatically after the Reagan and Kennedy tax rate reductions.
Republicans shouldn’t oversell an extension of the current tax rates as an economic panacea. Making the lower rates permanent would do far more for economic growth by removing one more source of uncertainty. And there are many spending and regulatory threats to growth that must be removed. But at least an extension would avoid a tax blow to a recovery that is still struggling to become a sustainable expansion.
Even in this lame duck liberal Congress, there is a bipartisan majority in both houses to prevent this tax increase. The only obstacles are a defeated, willful liberal minority that wants to extract one more pound of flesh from the private economy, and a President who still fails to comprehend that jobs and wealth are created outside of government and politics. If Democrats won’t compromise this month, the first vote in the new Republican House in January should be to repeal the Obama-Pelosi-Schumer tax increase.