Cut Tax Rates, Boost Tax Revenues
WASHINGTON-With the Republicans putting forward their own plan to avoid the fiscal cliff on Monday, Americans can easily become confused by debate language about taxes and revenues that is often arcane.
President Obama and congressional Democrats want higher tax rates, which they say will lead to higher revenues. Congressional Republicans will accept higher revenues, but not higher taxes. And some, chiefly Republicans, want lower tax rates, which, they predict, will lead eventually to higher revenues.
On Monday the Republican Speaker of the House, John Boehner of Ohio, announced that he favors $800 billion over the next decade in higher revenues, but not higher tax rates, which he and his party continue to oppose. His plan is based on suggestions made by Erskine Bowles, head of President Obama's deficit reduction commission, in November 2011.
Mr. Boehner believes that with lower tax rates, people will work harder and the government will collect more revenues.
In a letter to President Obama on Monday, Mr. Boehner and other House leaders wrote,
"Notably, the new revenue in the Bowles plan would not be achieved through higher tax rates, which we continue to oppose and will not agree to in order to protect small businesses and our economy. Instead, new revenue would be generated through pro-growth tax reform that closes special-interest loopholes and deductions while lowering rates."
In addition, Republicans proposed cutting $900 billion in entitlement spending and $300 billion in discretionary spending over the next decade.
Income tax rates, the fractions of your income Uncle Sam claims after allowing offsets for dependents and deductions, now range from 10 percent on each dollar of taxable income at the bottom of the scale to 35 percent of each dollar at the top of the income scale.
Many unincorporated businesses are taxed at individual rates. Corporations are taxed at a top rate of 35 percent.
Revenues, also known as receipts, are what the government gets from individuals and businesses after it has imposed the tax rates.
It used to be that life was simple. When tax rates went up, people assumed that revenues went up too. You want more revenues? You just raise taxes.
That's what President Obama is saying during these fiscal-cliff negotiations. The government has a deficit, he wants more revenue, so he proposes to raise the tax rates on millionaires, "the rich," defined as families making more than $250,000 of adjusted gross income annually in 2009 dollars, indexed for inflation. That's $267,000 on January 1, 2013.
Rates would rise to 42 percent, including a new top rate of 39.6 percent, a new Affordable Care Act tax of 0.9 percent, and a limitation of the use of personal exemptions and itemized deductions by top earners.
Mr. Obama predicts that would raise revenues by $1.6 trillion over the next decade, reducing the budget deficit, the excess of spending over revenue that must be borrowed.
But taxation isn't so simple anymore, if it ever was. When taxes go up, some people may cut back on work and risk-taking, especially investors and business people, people who may be employers.
That's one reason why, when the U.K. raised its top tax rate to 50 percent from 40 percent in 2010, the number of millionaires declined from 16,000 to 6,000 in 2012. Rather than rising, the revenue brought in to the U.K. Treasury declined by $11.2 million, or 2 percent. Some of the decline was due to Britain's recession, which began in 2011 and ended earlier this year. Higher tax rates may have contributed to the recession.
Now, Britain is reducing its top rate to 45 percent to try to bring back the millionaires.
Similarly, when Maryland imposed a millionaire's tax of 6.25 percent between 2007 and 2010, the number of Maryland residents shrank by 31,000 and state revenues declined by $1.7 billion. Higher taxes, lower revenues, and again the difference between a year of strong growth and one with weak growth.
One reason for changes in income is that some people receive income not only in the form of wages and salaries, but also as capital gains, or profits, on investments, usually securities or real estate. These capital gains are "discretionary." That is, owners of capital assets can choose when to cash out, to "realize" a gain. (Taxes must be paid only on "realized" gains.) If the tax rate goes up, some assets may not be sold.
If for whatever reason, such as a sagging stock market or higher tax rates, there is no net gain from capital, there is no taxable income, no revenue to Uncle Sam.
Boehner and Republicans believe that lower tax rates will encourage work and investment and raise revenues to the Treasury.
This is what happened in 2003-2006. In March 2003, the nonpartisan Congressional Budget Office forecast that the second phase of Bush tax cuts, enacted in 2003 with immediate effect, would reduce tax revenues in 2006 by $75 billion. Instead, 2006 revenues were $47 billion higher.
That was partly due to increases in capital gains tax revenues. When long-term capital gains tax rates declined from 20 percent to 15 percent in 2003, CBO projected that revenues would rise from $50 billion in 2003 to $68 billion in 2006. Instead, they rose to $103 billion. One reason: investors were making money in real estate.
Tax revenues have historically averaged 18 percent of GDP, ranging from between 17 percent to 20 percent of GDP, whether top rates were 90 percent or 28 percent. This suggests that the most efficient way to increase revenues is expand GDP, which has grown at less than 3 percent this calendar year.
In December 2010 the president said that the economy was growing at 2.4 percent, too slowly to raise taxes, because increases in taxes would constrict economic growth. In 2012, economic growth so far has been even slower, at 2 percent. Tax rates could rise in 2013, from congressional legislation or inaction, but the increase in rates will likely lead to slower growth and lower revenues.
In fact, the Congressional Budget predicts shrinkage of GDP growth by half a percentage point if the tax rises and spending cuts scheduled for January 1, the "fiscal cliff," take effect.
For a clear view of another way that lowering taxes could increase revenue, look no further than the corporate income tax. America has the highest tax rate in the industrialized world, at 35 percent, and taxes corporate income on a worldwide basis, rather than on the basis of income earned in America.
Lowering the rate to the average of 24 percent for the 34 member countries of the Organisation of Economic Cooperation and Development and confining corporate tax liability to what is earned in America rather than worldwide, would attract some business back to America and prevent others from leaving. This would expand revenues.
Congress and the president need to keep tax rates down so as to increase revenues in 2013.