Tax Hikes on Millionaires: Irrational and Foolish

Once again President Obama and the Democrats seek to stimulate the base human emotions of envy and resentment by demanding a surtax on “millionaires,” this time to “pay for” another year of temporary reduction in the Social Security payroll tax.  But it doesn’t really matter what they say the tax will “pay for.”  They always demand higher taxes on the rich, to pay for every idea they come up with.

Encouraging voters to blame their anxieties, fears and financial stress on the rich is one of progressive movement’s oldest and crudest campaign themes.

Obama can probably count on more enthusiasm from his emotion-driven base if he succeeds with millionaire tax increases.  But a review of history does not lead to the conclusion that government would collect more tax revenue or that non-millionaires who need jobs would be better off.  In fact, the opposite is more likely.

The chart above tracks both the effective tax rate and total tax revenue from millionaires who, like most of us pay taxes at different rates, for different categories of income.  One’s effective tax rate is the total dollar amount of tax paid (at various rates) divided by adjusted gross income.

The chart shows that tax revenue was falling before, and then increased dramatically after the Bush tax rates were enacted in 2003.   As the red line shows, the average, effective tax rate paid by all 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%.

But the rest of the story, as the above chart shows, is that the government collected more, not less tax revenue from taxpayers with million-dollar-plus incomes.

The “Bush tax cuts” were enacted in 2003 and are still in effect.  Revenue from millionaires grew an astonishing 128% from 2002 to 2007.  In 2007 more tax revenue was collected from millionaires than any previous year ever.

Then the recession hit and from 2007 to 2009 the number of taxpayers with incomes over $1 million dropped by 40%.   Revenue from millionaires fell by 43% but was still more than had been collected in 2002, the year before the current tax rates were enacted.

So what do Obama and his progressive friends want?  Shouldn’t they want to maximize tax revenue to the government to pay for all their various programs?  Shouldn’t they embrace the current tax rates as – to use one of their favorite words for government policy – “smart”?

Revenue from millionaires went up rather than down after the tax rates were lowered 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.
  • Stock dividends are the investors’ share of corporate profits remaining after payment of corporate income tax which is usually 35%.  The investor’s individual tax is in addition to the 35%.  When the individual tax rate on dividends was higher companies paid smaller dividends or no dividend at all because investors wanted to avoid taxation and preferred that profits to be deployed in ways that might enhance the market value of the stock.  After the individual rate was reduced investors wanted stocks that paid dividends and companies responded by paying more to attract those investors.  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 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.

Finally, the chart below tracks jobs and millionaire tax rates.  In 2007 there were more jobs than ever before at the same time millionaire tax rates reached their lowest.

As we disclosed in our previous post, fully 76% of millionaires are owners of small businesses. Increasing their taxes leaves them with less to invest in job creation.  History shows the most likely results of a surtax on millionaires will be less tax revenue and fewer jobs.  So why would Obama and the Democrats bet their futures on campaigning for such increases? We can only assume their pollsters tell him they’ll will win more votes by appealing to envy and resentment than by revealing the truth.

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