We now see who are
"millionaires and billionaires" in practice. They are individuals
with income over $400,000 or married couples with income over $450,000. Their
top tax bracket rises from 35% to 39.6%, an increase of 13%.
The capital gains tax rate
goes from 15% to 20%, an increase of 33%.
The temporarily reduced
payroll tax rate of 4.2% reverts back to 6.2%, an increase of 48% on all
wages up to around $110,000.
The spending problem was not
addressed.
There was one positive. The
threshold to be forced into the "Alternative Minimum Tax" was set
in 1993 and never adjusted for inflation. Incomes and prices have risen since
then, so today much of the middle class would be ensnared in this regime that
disallows most deductions including state income tax. Every year, Congress
provided a temporary fix, and now they have finally made it permanent.
An increase in the tax on high
incomes may not have a large immediate effect. Most high earners do not
consume all of their income. They spend what they need to maintain their
lifestyle and invest the remainder, though some may cut their consumption
budget to keep a fixed ratio of their income. The damage done by this tax
hike will be felt in future years, as it makes capital harder to accumulate.
Our economy (and job creation) depends on capital accumulation. This tax hike
in effect transfers capital out of the hands of those who may save it
prudently into the hands of the government to be consumed.
Raising the capital gains tax
rate strikes a blow directly at the entrepreneur and the investor. Fewer new
businesses make sense to start or finance. Investments in new businesses are
risky, and most are total losses to the investor. The few winners must earn
enough to pay for all the losers. A higher tax on gains raises the bar that
an investment must get over. There may be a long delay so that most will not
see the connection. In addition, it is difficult to imagine the products that
are not in the market but which would have been under a friendlier regime.
One thing is clear, mature businesses are managed to reduce cost, which often
means layoffs. Job creation is in new businesses. Higher taxes on capital
gains may only hurt a few people directly. The indirect impact will be felt
by everyone in the job market, along with every retail store, restaurant, and
manufacturer of consumer goods.
The payroll tax affects the
wage earner. I think it is safe to say that most of this reduction in take-home
pay will translate into a reduction in consumer spending and the remainder
will reduce the personal savings rate.
Taxes damage the economy in
another way. They cause distortion. People are not stupid. They react to the
incentives offered to them by the market or forced on them by the government.
How much has demand increased for accountants and lawyers and decreased for
fitness instructors? There is no way to calculate this, but we can say one
thing with certainty. The distortion increases with the tax rate.
The problem is that the
economy has become addicted to government spending. Withdrawal of this
powerful drug will be painful. Right now there is approximately zero
political will to make any cuts at all. For now, the government can get away
with it. Just as in Greece, the government depends on the bond market.
Whatever it cannot collect in taxes, it can make up by selling bonds,
including the interest on outstanding bonds.
And just like Greece, the game
ends when the bond market goes "no bid". This is not imminent in
the US. But it is inevitable.
