Bush Tax cuts: Revenue From Top 2% Went Up

Obama’s case against the Bush Tax Cuts is based on misinformation and deception.

Third in a three part series:  Part 1  Part 2

During his debate with Paul Ryan Vice President Biden attempted to deceive us regarding the Bush tax cuts and Romney’s proposed tax cuts.  In a jumble incomprehensible sentence fragments he hurled out a lot of figures that were intended not to inform, but to cajole a shocked reaction from the listener.  He said $800 billion “goes to” people making over a million dollars.  It wasn’t clear if that happened in the past or he he wanted us  to fear that it would happen in the future.

Biden’s use of the term “goes to”  is perhaps most enlightening because it confirmed the underlying assumption that everyone’s income is a government resource to be  distributed via political processes.  Biden and the Administration he represents consider the portion of if our income we are allowed to keep after taxes to be a grant to us from government.

The perception Joe Biden and the Obama campaign hope to plant in the mind of the listener is that the government’s cash shortage is caused not by the massive spending surge since 2009, but by the Bush tax rates being too generous to high income taxpayers.  But Biden, who probably doesn’t bother to look at government financial reports didn’t discuss the most significant tax revenue data. [continued below the chart]

The chart tracks income tax revenue from top bracket taxpayers earning over $500,000 from 1999 through 2009, the latest year for which IRS statistics are available.  It shows a dramatic revenue increase after tax rates were reduced in 2003.   As the red line shows, the average, effective tax rate paid by these high income taxpayers went down because the Bush tax cuts of 2003:

  • lowered the top tax bracket rate for “ordinary income” (salaries and business profits) from 39.6% to 35%
  • Lowered the top rate for capital gains from 20% to 15%
  • Lowered the top rate for stock dividends from 39.6 to 15%.

A taxpayer’s “effective tax rate” is the amount of tax dollars paid divided by adjusted gross income.  Typically, high income taxpayers’ effective rate results from a blend of ordinary income, taxed at 35%, and capital gains and dividend income taxed at 15%.

The “Bush tax cuts” enacted in 2003 are still in effect.  In 2007 more tax revenue was collected from high income taxpayers than any previous year, ever.

However, the recession caused a sharp drop in the taxable income of the wealthy, because most of their income is from investments and/or ownership of small businesses.  

As a consequence the chart above shows that revenue from high income taxpayers went down, even as their effective tax rate went back up, because the recession drove down income from capital gains and dividends.

If Obama’s only goal were to maximize revenue to the government he would enthusiastically support the current tax rates as – to use one of their favorite words for government policy – “smart” because:

  • The capital gains tax is voluntary.  It comes due only when an asset that has appreciated in value is sold.  Obviously, people are more likely to sell when the tax is lower.  Throughout it’s history the capital gains tax has consistently generated more revenue at lower rates and less revenue at higher rates.
  • Stock dividends are the investors’ share of corporate profits remaining after payment of corporate income tax, as high as 35%.  Thus the investor’s individual tax is a second levy on the same corporate profits.  When the individual tax rate on dividends was higher companies paid smaller dividends or no dividend at all because investors wanted to avoid double taxation and preferred profits to be deployed in ways that might enhance the market value of the stock.  After the tax rate on dividends was reduced investors looked for stocks that paid dividends and companies responded by paying more.  Thus, the government is now collecting taxes on dividend income that did not exist before the rate was brought down and would disappear and thus generate now tax revenue if the rate went back up.

In addition to to generating more revenue to the government, lower tax rates on dividends and capital gains also benefit the economy in general and those who seek jobs in particular:

  • When considering a new or expanding enterprise that may create jobs investors consider the risk vs the potential reward.  The tax they expect to pay in the future when the investment matures and they sell it is part of the consideration.  If the rate is higher they will be less likely to invest.
  • When people sell assets they look for new investments for the funds they receive, including business start-ups and business expansions that generate jobs.  If the capital gains tax rate is higher they are less likely to sell and thus, those new start-ups are less likely to come into existence.
  • When investors receive dividends they seek new investment opportunities for those funds, including job creating business start-ups and expansions.

By the way, taxpayers in all brackets pay lower rates on capital gains and dividends than they do on ordinary income.  In fact capital gains are tax free for taxpayers whose ordinary income rate is 15%, which would include most families who earn less than about $90,000, and some who earn even more.

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