President Obama’s standard campaign speech, already repeated to several audiences includes a new attack on millionaires:
…we live in the real world, with real choices and real consequences. Right now, we’ve got significant deficits to close. We’ve got serious investments to make to keep our economy growing. And we can’t afford to keep spending more money on tax cuts for millionaires who don’t need them and didn’t even ask for them.
The perception Obama hopes to plant in the mind of the listener is that the government’s cash shortage is caused not by his massive spending surge, but by the tax rates that apply to million dollar incomes.
The chart tracks income tax revenue from taxpayers earning over $1 million from 2000 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 millionaires 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 millionaires than any previous year, ever.
However, the recession was particularly harsh on millionaires.
- In 2007 approximately 3 of every 1,000 taxpayers earned more than $1 million.
- By 2009 the number had fallen by 40% to fewer than 2 of every 1,000 taxpayers earning over $1 million.
As a consequence the chart above shows that revenue from millionaires 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 taxed 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 when tax rates were higher and would disappear if the rates 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 people sell an asset 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 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 $80,000, and some who earn even more.