The Politics of Tax Rates

Posted by PITHOCRATES - December 19th, 2012

Politics 101

Cash Starved Small Businesses cannot Afford to pay a Dime more in New Taxes

America is staring at a fiscal cliff.  Thanks to the budget debt limit debate in 2011.  The US was in danger of running out of money and defaulting on their sovereign debt.  The Republicans controlled the House of Representatives.  And the House is in charge of the money.  Before increasing the debt limit the Republicans wanted to get some spending cuts to reduce the federal deficit.  The Democrats wanted to raise tax rates (letting the Bush tax cuts expire, returning to the Clinton tax rates) to reduce the deficit.  They couldn’t reach an agreement.  So they did what politicians always do when they want to run away from a problem.  Create a committee.

The so-called super-committee.  Tasked to come up with $1.2 trillion in spending cuts (over ten years) by the end of 2012.  Or else.  With the ‘or else’ being sequestration.  Automatic budget cuts in defense and entitlement spending to the tune of $1.2 trillion.  The politicians knowing how unpleasant sequestration would be were full of confidence that the super-committee would overcome hell and high water to complete their task.  Because sequestration would be so very, very unpleasant.  Of course, politicians being politicians, kept running away from that problem.  And now we’re staring into the face of sequestration.  Taxmageddon.  The fiscal cliff.  Because the Democrats want to raise taxes on everyone earning over $200,000 (single) or $250,000 (married filing jointly).  But Republicans don’t want to because that will raise taxes on the job creators.  Something that won’t make an anemic economic recovery any better.  So let’s look at the numbers and see what kind of damage we’re looking at.

President Obama’s proposal for new tax rates leaves everything at the 28% marginal rate and below the same.  He proposes increasing the 33% rate to 36%.  And the 35% rate to 39.6%.  The new rates kick in at earnings of $250,000 (all the examples here are calculated for a married couple filing jointly).  Which raises the top income band at the 28% rate.  Holding the net tax increase to only $1,115 for a small business owner with a net income of $350,000.  Which doesn’t seem that bad.  But a small business owner with a net income of $350,000 isn’t exactly rich.  Despite paying income taxes like they are rich.  For most small business owners are S corporations or LLCs.  With their net income passing through to their personal income tax return.  So if the business owner lives on enough to equal two incomes (say $75,000 X 2 = $150,000) so his or her spouse can be a stay-at-home spouse that $1,115 comes out of $107,045 ($350,000 – $92,955 – $150,000).  Which is all they can put back into the business.  To pay for new equipment (which isn’t enough for most purchases forcing them to borrow more money and go further into debt).  To repay debt.  To cover unpaid accounts receivable.  To pay for customer write-offs for an employee error on a project.  To pay for a production run that failed to meet specifications that they couldn’t sell.  To pay for inventory shrinkage (damaged, lost and stolen goods).  To pay for employee raises.  Bonuses.  To hire new employees.  Or to pay for the newly mandated Obamacare.  When you factor in all these cost issues a small business owner may face $107,045 of retained earnings is not a lot of money and leaves a very small cash cushion.  Which is why Republicans do not want to raise taxes on small business owners.

Taxing the Rich more will do nothing to Lower the Deficit

Then presidential candidate John McCain opposed then presidential candidate Barack Obama’s proposed tax rate increases in the 2008 campaign.  Saying it would raise taxes on 23 million small business owners.  FactCheck.org debunked this number saying the actual number is closer to 6 million.  So using their number the additional tax revenue from small businesses would equal about $6.7 billion.  Approximately 0.48% of the federal deficit.  Which will do nothing to reduce the deficit.  But it will take more money away from cash-starved small businesses.  So what about millionaires?  What’s their damage?  And how much will they reduce the deficit?

The proposed tax rates will increase a millionaire’s tax by $30,549.  According to the IRS there were about 119,810 tax returns filed by people earning a million dollars in 2010.  Meaning the proposed increase in tax rates would raise another $3.7 billion in tax revenue from those earning a million dollars.  Which is only 54.7% of the new tax revenue from small business owners generated by those same new tax rates.  And only 0.26% of the federal deficit.  Which will do nothing to reduce the deficit.  So what about richer people?  Will taxing richer people do anything to reduce the deficit?  Let’s look at the numbers for someone earning $5 million.

Someone earning $5 million will pay an additional $214,549 in taxes.  Which is a huge increase.  But according to the IRS there were only 16,574 people who earned $5 million.  Which brings the total increase in tax revenue to only $3.6 billion.  Which is a $100 million less than the millionaires.  And only 0.25% of the federal deficit.  Meaning it will do nothing to reduce the deficit.  Even though they are taking an additional $214,549 away from each person earning $5 million.  That’s a lot of money from each person that results in no significant deficit reduction.  Which is the purpose of the higher proposed tax rates.

We’re simply Spending More than our Tax Revenue can ever Hope to Pay For

Crunching these numbers further we find that the proposed higher tax rates will increase tax revenue by $38.2 billion for everyone earning a million dollars and more based on 2010 IRS tax information.  Which is only 2.7% of the federal deficit.  Which is less than the automatic increases included in baseline budgeting.  Which means these proposed tax increases won’t do anything to reduce the deficit.  In fact the deficit will still grow larger.  Thanks to baseline budgeting.

The problem is that there aren’t enough rich people to tax.  The top 10% of earners are already paying 70% of all federal income taxes.  To raise new tax revenue you have to go to the middle class.  Based on the IRS there were 44,637,653 people filing income tax returns who earned between $50,000 and $200,000.  If each of these people paid an additional $1,115 like those small business owners that would raise an additional $49.8 billion in tax revenue.  Which is 3.6% of the federal deficit.  If you increased their taxes by $2,500 that would increase tax revenue by $111.6 billion.  Or 8% of the federal deficit.  Which may actually keep the deficit from growing.  But it won’t pay it down.

To get serious deficit reduction from the rich you have to take very large sums of money from them because there are so few rich people.  And even then it’s probably not possible to raise tax revenue enough to offset the automatic spending increases included in baseline budgeting.  But it’s a different story with the middle class.  Because there are so many more people in the middle class than there are rich people.  You can keep the deficit from growing by taking a far smaller amount from each of them than you would have to take from the rich.  You could even take enough to overcome the automatic spending increases of baseline budgeting to keep the deficit from growing.  But even the middle class doesn’t have enough people in it to wipe out a $1.4 trillion deficit.  Or make a dent in the federal debt.

No.  The only way to make any significant deficit reduction is with spending cuts.  Which the Democrats are steadfast against.  Because spending is their power.  It’s why people vote for them.  Which is why they will fight for increasing tax rates to the bitter end.  And never negotiate them away.  To continue the facade that new revenue can reduce the deficit.  Even though no amount of new revenue can.  Only spending cuts can.  For our spending has long since passed the Rubicon.  We’re simply spending more than our tax revenue can ever hope to pay for.  And any further increases in tax rates only reduce economic activity.  Causing the small business owners to stand fast on expanding and hiring.  Because economic growth is rewarded with punitive taxation.  So they will grow less with every increase in tax rates.  And with every increase in tax rates tax revenues will fall.  Which will lead to a downward spiral of deficits, debt, lowered credit ratings and possible default.  But anything is better to Democrats than admitting they are wrong.

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