The Nation's Pulse

Redistributor in Chief

By From the June 2011 issue

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Several years ago I had a debate with my friend, Chris DeMuth, then the president of the American Enterprise Institute. We were discussing how conservative ideas on the economy had triumphed over the past 30 years on issues like the superiority of free trade and the evils of an inflationary monetary policy. We disagreed on supply-side tax policy: it was my hopeful view that after the undeniable success of the Reagan tax cuts and the rapid spread of supply-side economics around the world, with nearly every country sharply cutting their marginal tax rates on businesses and high-income individuals, no economist (aside from Paul Krugman, who is making a living by turning commonsense economics on its head) or learned politician would again embrace higher marginal tax rates. When even Russia and Sweden are cutting tax rates to get more competitive, the debate is pretty much over-or so it seemed. I truly believed that Art Laffer and Jack Kemp and Jude Wanniski had won by a knockout. Chris assured me that the left isn't there yet.

Well, Chris, I hate to admit it: you were right. There really are politicians in 2011 dumb enough to endorse raising tax rates, and unfortunately one of them occupies the Oval Office.

In his scathing assault on Rep. Paul Ryan and his "un-American" 2012 budget proposal that included a plan for reforming entitlements and reducing the debt, President Obama declared that it is merely an "article of faith" among Republicans not to raise taxes and that the millionaires and billionaires he hangs with want to pay more. Okay, quick: name three. I'm willing to wager that the Warren Buffetts may say they want to pay more, but they're not doing so. If every millionaire who will be contributing to the Obama reelection would give up just one percent of his wealth to the Treasury, that would at least pay for the subsidies to NPR and Planned Parenthood.

Obama's reversion to sock-it-to-the-rich economics shouldn't be surprising. How soon we forget that when he was running for president in 2008, and Charles Gibson of ABC reminded him that raising the capital gains tax was likely to lose revenues, then-Senator Obama said he would still favor this policy "for purposes of fairness." And it was entirely predictable that after passing the most expensive new entitlement program in 40 years (Obamacare) and an $800 billion stimulus plan, and cash for clunkers, and the bailout of the auto workers union, and spending $400 billion paying for bad mortgages, of course the bills are going to come due. And in what other honey pot are liberals going to look to pay for it all? You don't have to be a black helicopter conspiracist to wonder whether all of this was by design: go wild with preposterous spending plans, exclaim outrage over the ruinous deficits that spending spree caused, and then declare there is no alternative but to steal from the rich to pay the tab.

BUT LET'S SET ASIDE motives and blame and ask the question: Will any of this really work to reduce red ink? Obama thinks that raising the top tax rate back to where it was in the Clinton years from 35 percent now (while also layering a 4 percent investment surcharge to pay for Obamacare on top), and the capital gains and dividend tax rates from 15 percent to 23.8 percent and 42 percent respectively, is going to vacuum $700 billion over the next 10 years out of the pockets of those who earn more than $250,000. That assumes the rich won't do what decades of experience tell us they are very, very good at: shelter their income from the tax collector. After all, if highly profitable firms like General Electric and Whirlpool can, outrageously, find ways around paying even a penny of the highest corporate tax in the world, it's a good bet savvy investors with entourages of tax lawyers will do the same. The higher the tax rate, the greater the incentive to play the system like a pinball machine.

Incidentally, liberals keep saying that tax rates have to go higher because companies like General Electric paid no income tax last year. Guess what? Even if you raised the business tax rate to 90 percent, GE still would have paid no income tax.

Much to the glee of the left, polls now show a solid majority of Americans favor taxing the rich more. Perhaps that's because they've been saturated with press releases about how the rich make all the money and pay virtually no taxes. Obama repeated this fairy tale when he said that the rich are paying less than at any time in 50 years. Actually, he's not even close here. The richest 2 to 3 percent today pay a larger share of the tax burden than at any time in 50 years.

The system is so reliant on the collections from a small slice of rich Americans that in 2007, the top 3 percent paid more than 50 percent of all income taxes. In other words, the top 3 out of 100 paid more than the bottom 97 out of 100. That's not all that surprising given that this tax season almost 47 percent of tax filers did not pay anything at all. If the rich really do cough up $700 billion more in taxes, after 2013 the top 1 percent would pay nearly as much as the bottom 99 percent. By what weird definition does that constitute fairness?

But the wealthy aren't going to pay anywhere near that more in taxes, because people do change behavior when taxes are altered. Yes, Barack, there is a Laffer Curve. The White House has stumbled upon by far the least effective way to increase tax revenues and the most harmful to the economy. In the 1970s, the highest personal income tax rate was 70 percent, or twice the 35 percent rate today. Back then the wealthiest 1 percent paid 19 percent of all federal income tax. As the chart shows, Ronald Reagan cut tax rates to a high of 50 percent in 1981 and then to 28 percent in 1986. Rates seesawed back up to 39.6 percent under Bill Clinton then fell back to 35 percent in 2003 under George W. Bush. Over the whole period, as the tax rate was chopped in half, the share of income taxes paid by the wealthiest 1 percent doubled to 38 percent in 2008 from 17 percent in 1980. At a 70 percent rate in 1980 the top 1 percent paid $47 billion in federal taxes. Today, at a 35 percent rate, they pay more than $400 billion. Even adjusting for inflation, that is nearly a threefold increase in tax payments by the super rich. Yes, the taxable income of the rich soared over this period and all income groups saw gains. That's in part because as rates came down the economy zoomed ahead, making rich people richer, and in part because higher earners had less incentive to shelter earnings from the IRS with lower rates.

After the Reagan income tax cuts in 1981, the richest 1 percent doubled their income tax payments to $114 billion by 1988 from $50 billion in 1981 (all tax receipt figures here are in nominal terms). After the 1986 tax reform act, income tax payments by the rich rose from $70 billion to $146 billion by 1993. Now, it is true that after the Clinton tax increases, which lifted the top rate to 39.6 percent from 31 percent, revenues soared from $146 billion to $367 billion by 2000. Those revenues and the temporary surpluses they generated were, of course, artificially inflated by the high-tech stock market bubble that burst in 1999. By 2002 revenues had fallen back down to earth by nearly $100 billion.

The 2003 tax rate cuts that Obama wants to erase are pilloried by Democrats as a $1 trillion giveaway to the rich. But in the four years after those tax cuts, total tax receipts expanded by the largest amount of any four-year period in history. Payments by the rich increased to $451 billion in 2007 from $256 billion in 2003. Some of those revenue gains were also inflated by the housing bubble, but there was certainly no revenue loss.

The lesson of the last 30 years of tax policy is that what matters most in boosting tax collections is not the highest tax rate, but rather how fast the economy grows and how many jobs are created. It's hard to see how raising rates on those who are most economically productive and also most adaptive to tax policy changes is going to accelerate growth. That's especially true when considering that between 50 and 60 percent of the income subject to the new highest tax rate would be paid for by owners of subchapter S small businesses.

THE FINAL CHAPTER of this story is President Obama signing the two-year extension of the Bush tax rate reductions in December of 2010. I don't think it's mere coincidence that the mini-recovery that we are experiencing right now gained steam when Obama signed the two-year extension of the lower tax rates. And income tax revenues are up more than 10 percent so far this year-which is far higher than anyone predicted.

The very real risk is that the Obama tax hike he proposes in 2013 could condemn us to subpar economic growth for years to come, or worse yet, swerve the economy into a double-dip recession-at a time when we need desperately to rev up growth to put 20 million unemployed and underemployed Americans back to work. Another economic contraction would send the deficit into the even higher upper echelons of the stratosphere, and no doubt raise the volume on soaking the rich even further. Yes, I know, the Clinton tax hike of 1993 didn't cause a recession, but this is like winning the opening round of Russian roulette and concluding the game isn't so dangerous after all. Obama's increases are steeper than Clinton's, but more importantly, we're living in a world today with tax rates around the world much lower than 20 years ago. If the rest of the world is cutting tax rates to attract capital and jobs, while the U.S. is raising them, it's hard to see how that story has a happy ending for American workers. The major impact of the rate hikes will be to reduce the return on investment in the U.S. relative to other places-China, India, Germany, Brazil. The Obama tax hike can be likened to imposing an economy-wide tariff on investments that are made here and goods and services that are produced here.

None of these economic reality checks are likely to make any difference with the Obama crowd, for whom raising taxes on the wealthy truly isn't about reason, but, to borrow a phrase from the president, is "an article of faith." This proposal is about fulfilling a radical vision of redistributing income. The plan at its core would punish the heroes of the U.S. economy-those who work more and produce more-and give the money to those who work and produce less. Talk about un-American. 

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Stephen Moore is the chief economist at the Heritage Foundation.