Why President Obama's Tax Hike Will Hurt the 98%

President Barack Obama's campaign to raise tax rates on the top 2% will cause far more economic pain to the 98% than to the truly rich. The truly rich have already demonstrated their ability to avoid many of the Obama tax hikes and higher marginal rates will reduce opportunities for economic activity.

Charles Kadlec
12/03/2012 @ 12:31PM

President Barack Obama’s campaign to raise tax rates on the top 2% will cause far more economic pain to the 98% than to the truly rich. First, the truly rich have already demonstrated their ability to avoid much of the Obama tax hikes. At the same time, the higher marginal tax rates he demands will reduce the opportunities for economic activity, leading to slower growth and fewer job opportunities for the 98%. Finally, those with high incomes inevitably will shift much of the burden of Obama tax hike to those with lower incomes.

Let’s start with the ruse that the truly rich (as opposed to those who may make more than $250,000 in a single year of their life) will pay a lot more. These individuals have many ways to avoid the now higher tax rates. The perfect case in point is Costco co-founder, director and former CEO Jim Sinegal. In a prime-time speech at the Democratic National Convention, Mr. Sinegal explained why he supported President Obama:

Business needs a president who has covered businesses’ backs. A president who understands what the private sector needs to succeed. A president who takes the long view and makes the tough decisions. And that’s why I am here tonight supporting President Obama, a president making an economy built to last. See, in order for companies like Costco to invest, grow, hire and flourish, the conditions have to be right. That requires something from all of us. (Emphasis added.)

Well, apparently all of us except Mr. Sinegal and his truly wealthy fellow Costco Board Members, who include such advocates for higher taxes as William Gates Sr. and Charles Munger.

Last Wednesday, Costco announced that it would borrow $3.5 billion so that it could pay a special dividend of $7 a share before the end of the year. Call it a six-year advance on the company’s current annual dividend of $1.10 per share. According to The Wall Street Journal, Mr. Sinegal owns two million shares, and will collect $14 million which will be taxed at the current 15% rate instead of the 43.4% rate called for by the President he supports. By paying out the dividend before year end, Mr. Sinegal alone will avoid paying $4 million in taxes to support all that he favored in his Convention speech: government funded education, innovation and research, affordable energy, safe and efficient transportation system, and, of course, paying down the government’s debt.

Talk is cheap. Paying taxes is expensive and worth avoiding — even by those who believe in government and “taxing the rich”.

The President’s claim that the 98% will not be hurt by a tax increase on “the rich” is at the heart of the great deception of liberal/progressive orthodoxy.

We normally think of taxes as being imposed on individuals or corporations. While true in the sense that individuals or corporations pay the tax, it also is misleading. A sales tax, for example, is paid by the merchant and charged to the customer, but it falls on the activity of the buying and selling of goods. No sale, no tax due.

In exactly the same way, income taxes are actually levied on the generation of income through market activities. And, market activities are always based on the discovery and execution of exchanges which make both parties better off. As Adam Smith explained in The Wealth of Nations:

Whoever offers to another a bargain of any kind, proposes to do this. Give me that which I want, and you shall have this which you want, is the meaning of every such offer; and it is in this manner that we obtain from one another the far greater part of those good offices which we stand in need of.

Income and sales taxes create an obstacle or barrier to such mutually beneficial exchanges by reducing what each party gets from the other. They are rightly considered tariffs, only they are imposed on trade among domestic participants instead of trade among participants on two sides of a political border. We all know that increasing tariff barriers leads to less international trade. In the same way, an increase in marginal tax rates leads to less domestic trade or economic activity.

Here’s why:

Think of an item that costs $100 that is suddenly subject to a 10% sales tax. Imposing the sales tax initially raises the price of the good to $110. When the price paid of a good goes up, the demand for that good goes down.

However, the price received is unlikely to remain at $100. At this price, the producer is willing to produce more than enough to meet the now lower demand. What happens next is never discussed by politicians, and mentioned only by a few pundits. Faced with less demand, the producer has to either produce less, or lower her price. If both the buyer and seller have equal responses to the change in price, then the tax will be split: the producer would lower her price to $95 – a price at which she is willing to produce less, and the buyer would face a price of $104.50 – a price at which demand now equals the lower supply.

How does raising tax rates on the affluent (and rich) hurt the working class? For an individual such as a contractor or gardener, taxi driver or hair stylist to take home $30,000 after tax, their non-business employers or customers would have to supply nearly $60,000 of goods or services in exchange! And, that is in a state with no income tax.

Here is how it works. To clear $30,000 after payroll and federal income taxes a married individual filing a joint return with no dependents has to be paid nearly $37,000 to cover $4921 in payroll taxes and $1779 in federal income taxes. But, to produce $37,000 net of the income (35%) and the Medicare payroll tax (2.9%), an individual in today’s top tax bracket has to earn an additional $59,581.

Under the President’s proposal, individuals earning $37,000 would see no increase in their taxes. But, the combined income/payroll tax rate on their customer would rise to 43.4% (39.6+3.8). That means, their customers would now have to earn $65,371 to net the $37,000, an increase of $5790, or 10%.

So, the contractors, gardeners and all others who provide services to the “2%” now face a double whammy. First, their customers have less money to spend after tax. And second, their pre-tax price just went up 10%. Like it or not, such a price increase on families with less disposable income will lead to a combination of less employment and lower wages for those who do business with the 2%.

Unlike the example of the sales tax above, much of the burden of the higher tax rates are likely to fall on those who provide services to the 2%. The family with an income of more than $250,000 may suffer the inconvenience of not upgrading their kitchen. But, the contractor loses all of the income that he would have earned, and the people he otherwise would have employed lose their jobs. Their ability to enter into mutually beneficial exchanges have also been impaired, leading to a further decline in income earning opportunities for the 98%.

Democratic folklore includes the myth that the Clinton tax increases led to the 1990s boom. In fact, the Clinton tax increase on those with incomes above $400,000 in 2012 dollars slowed the economic recovery that should have been gaining strength due to the end of the Cold War and the restoration of price stability for the first time since 1965. The Clinton boom was delayed until his second term when barriers to international and domestic trade were lowered by the reduction of tariffs under the North American Free Trade Act, welfare reform, and a cut in the capital gains tax rate.

“Tax the rich” may be a great slogan. But the consequences of the President’s economic policies will fall most heavily on those with modest incomes who will suffer the loss of jobs and promotions due to the shrinking opportunities for mutually beneficial exchanges.

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