Taxing the wealthy is bad news for everyone

The new US health care law will substantially increase the tax burden of high-income workers and small businesses over the next few years. The tax hikes will reduce the capital stock and discourage small business job creation – the opposite of what is needed to grow the economy, says Pamela Villarreal, a senior policy analyst with the National Center for Policy Analysis.

Consider:

The 2001 Bush tax cuts reduced the lowest marginal income tax rate from 15 per cent to 10 per cent and the highest from 39.6 per cent to 35 per cent.

President Obama proposes to raise the two top marginal rates to 36 and 39.6 per cent beginning 2011 for the highest-income earners while leaving the other tax brackets unchanged.

Beginning in 2013, the new health care reform law will impose an additional 0.9 per cent Medicare tax on wage income for individuals earning more than $200,000 a year and couples earning more than $250,000.

Additionally, the new law imposes a 3.8 per cent Medicare tax on unearned income, such as rent, royalties, dividends and capital gains for the same high-income earners.

The Obama administration also wants to increase long-term capital gains tax rates from 15 per cent this year to 20 per cent in 2011 for the two highest tax brackets, and taxing dividends at ordinary income tax rates for those earning $200,000 a year or more.

How will this affect the above income groups? Suppose an individual owns $50,000 worth of stock that has accumulated an 8 per cent capital gain and 3 per cent dividend after one year:

By 2013, the tax on the $4,000 gain (sold after one year) would be as much as $1,309, compared to $825 if the current tax cuts are extended.

With the current capital gains tax rate of 15 per cent, the tax on the sale of $50,000 in stock would be $825, and the after-tax rate of return would be 9.35 per cent.

If President Obama's proposed capital gains and dividends rates of 20 per cent go into effect, along with the new Medicare taxes, the tax bill rises to $1,352 and the after-tax rate of return falls to 8.38 per cent.

For ordinary dividends, a higher marginal tax rate and the new Medicare taxes could nearly double the individual's effective (average) tax rate from 15 per cent to more than 29 per cent.

Thus, for high earners the after-tax rate of return on this type of investment would fall by more than 10 per cent, or more than one percentage point, says Villarreal.

Increasing the capital gains tax could lower government tax revenues, because people will hold on to assets in order to avoid the tax. This lock-in effect has been noted when capital gains tax rates increased in the past. Moreover, the lower rate of return resulting from higher taxes may discourage people from investing in certain capital assets in the first place, says Villarreal.

Source: Pamela Villarreal, Higher Taxes on Capital Gains and Dividends, National Center for Policy Analysis, Brief Analysis No.701, April 8, 2010.

For text: http://www.ncpa.org/pub/ba701

For more on Taxes: http://www.ncpa.org/sub/dpd/index.php?Article_Category=20

First published by the National Center for Policy Analysis, Dallas and Washington, USA

FMF Policy Bulletin/ 13 April 2010