October 31, 2014 | Commentary on Economy, Economic Growth, Recession and Recovery

Obama Soaks the Rich, Drowns the Middle Class

The curse of the U.S. economy today is the downward trend in “take-home pay.” This is the most crucial economic indicator for most Americans, but when President Obama said in a recent speech at Northwestern that nearly every economic measure shows improvement from five years ago, he conspicuously left this one out.

Most workers’ pay has not kept up with inflation for at least six years. Even as hiring picked up over the past year, wages and salaries have inched up by 2%, barely ahead of inflation. This probably explains why half of Americans say the recession never ended. They are experiencing what Federal Reserve Chair Janet Yellen last week described as “stagnant living standards for the majority.”

Why aren’t wages rising? There are several reasons, including that many jobs today don’t pay as well as the ones lost during the recession. ObamaCare has made health insurance more expensive for businesses—as the nation’s biggest employer, Wal-Mart , recently reported—and that takes a bite out of take-home pay. Yet one factor is often overlooked: the tax increase on “the rich” at the beginning of 2013.

How could higher taxes on the top 2% or 3% hurt the middle class? Part of the answer is that when upper-income Americans spend their money on vacations or cars, they are taxed only once, after they earn it. But if they put their money to work by, for example, building out a family business, they got socked a second time by higher investment taxes. And this discourages the investments that grow the economy.

Although the Obama administration argues otherwise, these tax hikes were not minor. The tax rate on capital gains for high-income earners shot up to 23.8%—20% plus the 3.8% ObamaCare investment surtax. Ditto for the tax on dividends. So taxes on business investment rose by nearly 60% in 2013 and are nearly 20% higher than in the Clinton years.

For estates more than $5.3 million in value, the estate tax in 2013 rose to 40% from 35% in 2012. This tax is a confiscatory double tax on a lifetime of savings, and the money reinvested in stocks or a family business.

The overall effect of the 2013 tax hike was not minor. The highest income-tax rate on small business income has risen to almost 42% from 35%. That’s a 20% spike in the small business tax for successful companies. When the government takes more, there is less to plow back into the business or invest elsewhere.

This may help explain the paradox that even as American businesses today are generally efficient and highly profitable, they aren’t reinvesting in new plants, equipment and technology or hiring more workers at the pace they normally would. Business investment was up last quarter—a hopeful sign—but over the recovery the trend has been sluggish.

A comparison with the Reagan years when investment taxes were cut tells the story. From 1983 to 1988, private investment averaged 12% of GDP, one-third faster than the 9% since 2009 under Obama. In the aftermath of the Kennedy, Clinton and George W. Bush capital-gains tax cuts (1998-2006), the investment rate rose sharply and immediately.

What does investment have to do with stagnant wages? Everything. As Paul Samuelson, the premiere Keynesian economist who sold more economics textbooks than anyone in history, once explained: “What happens to the wage rate when each person works with more capital goods? Because each worker has more capital to work with, his or her marginal product [or productivity] rises. Therefore, the competitive real wage rises as workers become worth more to capitalists and meet with spirited bidding up of their market wage rates.”

History bears this out. Workers did very well in jobs and rising incomes in the 1960s, 1980s and late 1990s when capital gains and dividend taxes fell.

The high corporate tax rate is also holding the economy back. Twenty years ago the U.S. rate was about at the international average, but now we are about 15 percentage points above the rate of most of our competitors and nearly three times higher than countries like Ireland. The American Enterprise Institute has found that “a 1% increase in corporate tax rates is associated with nearly a 1% drop in wage rates” because when corporations invest less here at home, worker productivity suffers.

Mr. Obama’s investment tax hike was designed to soak the rich. But it is the middle class who have taken a bath. Republicans should be telling American wage-earners that the best way to increase their take-home pay is to repeal Mr. Obama’s tax hikes and chop the corporate tax rate to the international average, so more and better jobs are created on these shores, not abroad.

Editor's Note: Jon Kyl co-authored this commentary.

 - Stephen Moore is chief economist at The Heritage Foundation.

 - Jon Kyl is a visiting scholar at the American Enterprise Institute and senior counsel at Covington & Burling LLP.

About the Author

Stephen Moore Distinguished Visiting Fellow
Project for Economic Growth

Originally appeared in The Wall Street Journal