newjerseynewsroom.com

BY MICHAEL BUSLER

COMMENTARY

Multi-billionaire Warren Buffett pays a lower tax rate than his secretary.  President Obama pays a lower tax rate than his secretary.  At a time when huge government budget deficits require increases in tax revenue, are the lower tax rates on high income earners justified?

President Obama says no.  He argues that all Americans should pay their fair share.  While it is difficult to determine exactly what a fair share means, most Americans (as many as 60 percent according to one recent Gallup poll) think the wealthy should pay higher rates than they are currently paying. So the President would like to see those earning more than $1 million pay at least 30 percent in taxes. According to the Congressional Joint Committee on Taxation this rule would increase tax revenues by about $4.5 billion per year.  More importantly, the President says, it will increase the perception of fairness.  Will it?

The reason that Buffett and Mitt Romney and other wealthy individuals pay tax rates in the 15 percent to 18 percent range, is that most of their income is in the form of capital gain (the profit realized on the sale of an asset), rather than the ordinary income earned by their secretaries.  So if we raise the rate from the current level of 15 percent to 30 percent, it would create the perception of fairness and increase revenue, even if by only a relatively small amount. The reality, however, may be quite different.

The first question is: “Will higher tax rates on capital gains increase tax revenue?” The answer, according to past practice is “NO.”  At one time capital gains were taxed at 28 percent. Congress lowered the rate to 21 percent and tax revenue increased.  Then when it was raised back up to 28 percent, tax revenue decreased. The reason for this is not that difficult to understand.

Let’s say that at a rate of 30 percent there is a total of $1,000 of capital gain which would generate $300 in revenue. If the rate is cut to 15 percent, investors, attracted by the lower rate, will take as much of their current income as possible and invest it Plus they would be able to re-invest 85 percent of their current gains. The lower rate will likely attract so much more investment that total gains will quickly increase to $3,000.  So when the government taxes 15 percent of $3,000, they raise $450 in revenue, a significant increase over the $300 raised when the tax rate was 30 percent. Indeed the lower rates vastly increase economic activity and lead to an increase in tax revenue. And isn’t that the primary goal?

On the issue of fairness, we must remember that people pay dollars not percentage points. While it is true wealthy investors, who earn most of their income through capital gains, tend to be taxed at a lower rate, they pay more dollars than they would pay when the rate is higher. And look at how many more dollars Warren Buffett paid. He paid $7 million in taxes last year. His secretary paid about $40,000.  And people think Buffett is not paying his fair share?  The secretary likely receives more services than Buffett does, yet pays about one-half percent of what Buffett pays in taxes.  Is that fair?

The other negative side effect to raising the capital gains tax rate is that it will contribute to slower growth and inflation. Again this is not difficult to see.  As the economy recovers and demand increases, business must respond to this. Their first choice, as a response, is to increase output to meet the increased demand.  In order to do so, they need labor and capital.  Because the unemployment rate is over 8 percent, there is plenty of labor available.  But if the tax rate on capital gains is raised, it will reduce the amount of capital available so that the businessperson may not be able to expand.  If he can’t expand, then the only response to increased demand is for him to raise his price.  The result is slower expansion, higher unemployment and more inflation.  Remember the stagflation of the 1970’s?  Remember how we fixed it?  We lowered tax rates for everyone, especially for those who create capital. The result essentially was a 27 year expansion (with minor setbacks in 1991 and 2001).

If we want to increase tax revenue, grow the economy, reduce unemployment and put downward pressure on prices, we must not raise capital gain tax rates.  While raising the rates may seem popular in the short term, in the long term it is counter-productive for all Americans.

Michael Busler is an Associate Professor and a Fellow at the William J. Hughes center for Public Policy at Richard Stockton College.

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