I guess the Obama economists missed that opening day lesson on incentives

One of the most basic lessons in economics is that people respond to incentives. They will adapt their behavior according to the incentives. But apparently, the people putting together Obama's budget writers missed that day's class in Economics 101.

In keeping with Obama's campaign promises not to tax the middle class, he's hoping to gain the money he needs for all his spending goals by increasing taxes on the wealthy. And they're looking to whatever they can increase to get more money from those higher earners. Here is one example.

About half of the money that Obama wants to raise for a healthcare overhaul would be generated through changes in the way that the wealthiest Americans itemize deductions for charitable donations, state taxes or interest payments on a home.

Under the president's proposal, joint filers making more than $250,000 a year would only recoup 28% of the value of qualified deductions, rather than higher percentages laid out under current law.

That could mean a couple in the 35% tax bracket who once could have recouped $3,500 of a $10,000 donation to a charity would now recoup only $2,800.

The White House estimates the change would generate about $318 billion over 10 years.

Maybe some of the old-timers around the Hill could tell the young'uns about what happened in 1990 when the Democrats thought they'd raise oodles and boodles of money by putting a tax on luxury goods like yachts.

"Starting in 1991, Washington levied a 10 percent tax on cars valued above $30,000, boats above $100,000, jewelry and furs above $10,000 and private planes above $250,000. Democrats like Ted Kennedy and then-Senate Majority Leader George Mitchell crowed publicly about how the rich would finally be paying their fair share and privately about convincing President George H.W. Bush to renounce his 'no new taxes' pledge," the newspaper [Wall Street Journal] said in an editorial.

"But it wasn't long before even those die-hard class warriors noticed they'd badly missed their mark. The taxes took in $97 million less in their first year than had been projected — for the simple reason that people were buying a lot fewer of these goods. Boat building, a key industry in Messrs. Mitchell and Kennedy's home states of Maine and Massachusetts, was particularly hard hit. Yacht retailers reported a 77 percent drop in sales that year, while boat builders estimated layoffs at 25,000. With bipartisan support, all but the car tax was repealed in 1993, and in 1996 Congress voted to phase that out too. January 1 was disappearance day.

So what do you think will be the response of upper income people as they lose some of their tax deduction for charitable donations? That's right, they'll decrease their donations. And in these economically parlous times, is that really what we want to have happen? Charities are already reporting a drop in donations.

"The way the economy goes determines how charity goes," said Melissa Brown, associate director of research at the Center on Philanthropy at Indiana University in Indianapolis.

Total giving figures for last year will not be available until June, but "many charities are reporting lower income from donations," she said.

Surveys of the largest 100 United Ways in December and January suggest a decline of 2% to 5.6% in giving this year.

More than half of the United Ways - 58% - are expecting a drop this year, said Sally Fabens, a spokeswoman for the charity.

In addition, 82% are anticipating higher rates of uncollectible pledges, she said.

Perhaps the Democrats don't mind such a drop because they anticipate making up the shortfall with more government programs that they'll make by taxing the wealthy even more.

But they need to understand that they're never going to get enough money from squeezing the top earners. The Wall Street Journal explodes the faulty arithmetic behind such administration calculations.

Consider the IRS data for 2006, the most recent year that such tax data are available and a good year for the economy and "the wealthiest 2%." Roughly 3.8 million filers had adjusted gross incomes above $200,000 in 2006. (That's about 7% of all returns; the data aren't broken down at the $250,000 point.) These people paid about $522 billion in income taxes, or roughly 62% of all federal individual income receipts. The richest 1% -- about 1.65 million filers making above $388,806 -- paid some $408 billion, or 39.9% of all income tax revenues, while earning about 22% of all reported U.S. income.

Note that federal income taxes are already "progressive" with a 35% top marginal rate, and that Mr. Obama is (so far) proposing to raise it only to 39.6%, plus another two percentage points in hidden deduction phase-outs. He'd also raise capital gains and dividend rates, but those both yield far less revenue than the income tax. These combined increases won't come close to raising the hundreds of billions of dollars in revenue that Mr. Obama is going to need.

But let's not stop at a 42% top rate; as a thought experiment, let's go all the way. A tax policy that confiscated 100% of the taxable income of everyone in America earning over $500,000 in 2006 would only have given Congress an extra $1.3 trillion in revenue. That's less than half the 2006 federal budget of $2.7 trillion and looks tiny compared to the more than $4 trillion Congress will spend in fiscal 2010. Even taking every taxable "dime" of everyone earning more than $75,000 in 2006 would have barely yielded enough to cover that $4 trillion.

And that is not even accounting for the weakened economic picture today that translates into fewer taxpayers in that top bracket. And many of those people are those small business owners that politicians are always vowing to protect.

Mr. Obama is of course counting on an economic recovery. And he's also assuming along with the new liberal economic consensus that taxes don't matter to growth or job creation. The truth, though, is that they do. Small- and medium-sized businesses are the nation's primary employers, and lower individual tax rates have induced thousands of them to shift from filing under the corporate tax system to the individual system, often as limited liability companies or Subchapter S corporations. The Tax Foundation calculates that merely restoring the higher, Clinton-era tax rates on the top two brackets would hit 45% to 55% of small-business income, depending on how inclusively "small business" is defined. These owners will find a way to declare less taxable income.

So Obama is selling a pipe dream if he thinks he can fund all his new spending plans simply by cutting spending in Iraq and taxing the wealthy. And he's discounting how such policies work in the real world. Perhaps one of the breakout sessions of the next summit on fiscal spending could include a talk on incentives, tradeoffs, and unintended consequences.