How Will Obama's Tax Plan Impact the Economy?

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This year’s presidential election has sparked perhaps the most intense and lengthy discussion of taxes since the campaign of 1988, when George H.W. Bush infamously told the GOP convention to ‘read my lips: No new taxes.”

Barack Obama has generated much of this year’s discussion with his plan to raise taxes on those earning $250,000 and up and reduce them on middle and lower income families. There’s even been an increasingly heated debate online about whether people who earn $250,000 annually can be classified as rich. But as fascinating as the discussion has become, we seem to be drifting away from the important question of what impact do taxes have on work and productivity (and hence the economy), especially among our most industrious and innovative citizens--those whom Ayn Rand once said powered the “motor of the world”?

To understand what’s at stake it’s important to consider not just how much money people earn, but how much in income taxes they now pay. We seem to have lost sight of how drastically this differs for households in different brackets. Simply put, at $250,000 in taxable annual income, a married couple filing taxes jointly would now pay about $62,000 in federal income taxes. By contrast, a couple earning $50,000 a year, which is about the median income in the U.S., would pay $6,750 in taxes. Although the $250,000 couple is in the 33 percent tax bracket (meaning every additional $1 in taxable income they would earn is taxed at 33 percent), the couple is actually paying about 25 percent of their total taxable income to the feds. At the same time, the median income couple pays about 13.5 percent of their income in taxes. In actual dollars, this translates into slightly less than 10 dollars in taxes from the higher income couple for every one collected from the median income family.

This ratio stays pretty much the same if one considers the impact of all federal taxes, not just the income tax, on these same households, according to the nonpartisan Congressional Budget Office. In its study Historical Effective Federal Tax Rates, the CBO noted that we actually pay a host of federal taxes in addition to the income levy, including the payroll tax, excise taxes and even corporate taxes, whose cost is borne ultimately by individuals. Figuring all federal taxes into the mix, as well as income from all sources, including government transfers, the CBO study suggests that the effective tax rate of a family with a taxable income in the range of $250,000 remains at slightly under double that of a couple earning $50,000.

Now Barack Obama and people who think like him would look at these numbers and argue that, after paying income taxes, the $250,000 family still has about $188,000 left to spend on other things (including paying other federal, state and local taxes, housing, food, etc.), while the $50,000 family has about $43,250 left. That’s too much of an imbalance so let’s raise taxes on the higher income family to finance cuts for middle income earners and programs that provide lower income families with assistance, says Obama. He calls this his attempt to create "a sense of balance fairness in our tax code." He personalizes it by adding that, "It is time for folks like me who make more than $250,000 to pay our fair share."

But looking at these numbers, the larger question for the economy is, at what point when we tax someone’s additional earnings in order to make our tax system ‘fairer’ does that person simply work less because government is taking so much more of the fruit of his effort (up to 39.6 percent under Obama’s plan, in addition to state taxes)? One could fill an entire library with economics dissertations on this subject, though it’s at least safe to say that the disincentive to work under Obama’s plan won’t be as great as it was when our top tax rate was 90 percent, but it will be greater than it is under today’s tax rates.

But the larger question is how much of an impact would it have on our economy if these folks did indeed work less? Can the rest of us simply pick up the slack if our most productive and innovative workers cut back, or do these folks add something that can’t easily be replaced? Judging by comments on some websites I’ve seen, many people view high income earners as little more than privileged exploiters, or slackers with good family connections, or people who just happened to be in the right place at the right time.

By contrast, it was Rand who recognized that this group also includes our most pioneering and inventive workers, the individuals “of the mind” whose innovations and ambitions drive the motor of the world and who are responsible over time for creating modern society, without which the rest of us would still be tilling ground in some pre-industrial world.

And so the debate about taxes is really a debate about the role that our biggest earners play in our economy. Increasingly, those who sit at the center of the Democratic Party seem to minimize that role. One theme of the Democratic convention last week was that government works, and that apparently applies especially to the economy. And so op-ed columnists now tell us that the real key to growth is the Democratic model of using government to drive the economy through vehicles like research dollars (although those research dollars come from taxes on private earnings). We seem likely headed, in other words, toward a period of rule by those who believe that it is government which is the motor of the world, and that it’s selfish to think about keeping too much of the fruits of your labor for yourself.

Will the rich, the productive, the inventive, buy it? Or will they see their ambition and learning and invention as unappreciated and overtaxed, and withdraw some of it, at great cost to society? It will be an interesting and revealing experiment.

Steven Malanga is an editor for RealClearMarkets and a senior fellow at the Manhattan Institute

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