Tuesday, March 30, 2010

Paying for new spending by taxing the rich

Almost everyone seems to approve of taxing the wealthy. A new Quinnipiac poll shows that a strong majority of the American people think that it's just fine to pay for the federal spending by taxing the wealthy.
The Quinnipiac University poll found that 60 percent of Americans among both major political parties think raising income taxes on households making more than $250,000 should be a main tenet of the government's efforts to tame the deficit. More than 70 percent, including a majority of Republicans, say those making more than $1 million should pay more.
Well, duh. Of course, the people like taxing someone else.

The only problem is that we can't pay for all of the government spending we've taken on by taxing the rich. Alan Reynolds has a detailed piece in the WSJ explaining how taxes on the rich never produce as much money as expected. But that is how Obama and the Democrats anticipate funding their spending.
President Barack Obama's new health-care legislation aims to raise $210 billion over 10 years to pay for the extensive new entitlements. How? By slapping a 3.8% "Medicare tax" on interest and rental income, dividends and capital gains of couples earning more than $250,000, or singles with more than $200,000.

The president also hopes to raise $364 billion over 10 years from the same taxpayers by raising the top two tax rates to 36%-39.6% from 33%-35%, plus another $105 billion by raising the tax on dividends and capital gains to 20% from 15%, and another $500 billion by capping and phasing out exemptions and deductions.

Add it up and the government is counting on squeezing an extra $1.2 trillion over 10 years from a tiny sliver of taxpayers who already pay more than half of all individual taxes.

It won't work. It never works.
Reynolds cites research showing that the wealthy aren't stupid and they react to higher tax rates. They find ways to put their money so that they won't have to pay as much in taxes. Perhaps that is how they got to be rich in the first place.
In short, the evidence is clear that when marginal tax rates go up, the amount of reported incomes goes down. Economists call that "the elasticity of taxable income" (ETI), and measure it by examining income tax returns before and after marginal tax rates claimed a bigger slice of income reported to the IRS.
According to historical examples, raising taxes on the wealthy will not only raise close to half of the money that Obama's budget forecasts are counting on, but could even lead to pulling in less revenue than prior to the tax increases.
In short, the belief that higher tax rates on the rich could eventually raise significant sums over the next decade is a dangerous delusion, because it means the already horrific estimates of long-term deficits are seriously understated. The cost of new health-insurance subsidies and Medicaid enrollees are projected to grow by at least 7% a year, which means the cost doubles every decade—to $432 billion a year by 2029, $864 billion by 2039, and more than $1.72 trillion by 2049. If anyone thinks taxing the rich will cover any significant portion of such expenses, think again. The federal government has embarked on an unprecedented spending spree, granting new entitlements in the guise of refundable tax credits while drawing false comfort from phantom revenue projections that will never materialize.
How then will we pay for all this spending? We won't be able to pay for it simply by taxing the rich so you know where the taxes will fall next. How popular will large tax increases on the middle class be? That same Quinnipiac poll shows that 80% of those polled oppose taxing those they don't consider rich.
But 80 percent say raising taxes on those making less than that should not be part of the government's approach. Moreover, most oppose touching Medicare and Social Security - two long-term drivers of the budget deficit over the coming decades.
Well, we can't have our cake and eat it too. Something has got to give. Those politicians who have been promising that it is possible to pay for an entire new health care entitlement on top of our doomed commitments to entitlement spending all by taxing the rich have been selling a pipe dream. We know how Obama pretends to like experts and scholarly studies. He should pay attention to what economists know about the failure of taxes on the rich to produce the kind of money he has been counting on.