Note: Representatives of the Obama campaign
have informed the authors that the campaign is not committed to the
full 12.4 hike in the payroll tax. An increase in the payroll
tax is merely one of many different tax increases that are being
considered for those making over $250,000. The Obama campaign
implies that the tax increase on those earning over $250,000 may
not be limited to earnings but also cover different types of
income. Despite questioning, the campaign has not provided any
more details.
Presidential hopeful Senator Barack Obama (D-Ill.) has unveiled
his economic plan of raising taxes on the successful. His plan
would boost the top marginal rate to well over 55 percent-before
the inclusion of state and local taxes-resulting in many
individuals seeing their marginal tax rate double. The consequences
of this policy would be a return to the bad old days of tax
avoidance, with taxpayers disguising personal income as business
income or capital gains and the migration of capital from the
United States to abroad.
Among the more prominent elements of his tax proposal, Senator
Obama would end the Bush tax cuts and allow the top two tax rates
to return to 36 and 39.6 percent. He also would allow personal
exemptions and deductions to be phased out for those with income
over $250,000. The real kicker, though, is that
Senator Obama would end the Social Security payroll tax cap for
those over $250,000 in earnings. (The cap is currently set at
$102,000.) These individuals will then face a tax
rate of 15.65 percent from payroll taxes and the top income tax
rate of 39.6 percent for a combined top rate of over 56 percent on
each additional dollar earned.
High-income individuals will be forced to pay even more if they
live in cities or states with high taxes such as New York City,
California, or Maryland. These unlucky people would pay over
two-thirds of each new dollar in earnings to the federal
government.
How the Obama Tax Plan Compares to Other
Countries
Senator Obama's new tax rate would give the United States one of
the highest tax rates among developed countries. Currently only six
of the top 30 industrial nations have a tax rate for all levels of
government combined of over 55 percent. Under the Barack Obama tax plan, the
United States would join this group and have a higher top rate than
such high-tax nations as Sweden and Denmark. The top marginal rate
would exceed 60 percent with the inclusion of state and local
taxes, which means that only Hungary would exceed Senator Obama's
new proposed top tax rate.
The costs in economic terms of such high taxes are real. For
example, of the six countries with higher tax rates than 55
percent, the average unemployment rate is 7.35 percent (see chart).
This figure includes Denmark, which appears to have a very low
unemployment rate of 3.9 percent. However, Denmark spends over 5
percent of its GDP on unemployment programs and benefits, thereby
increasing its unemployment rate.[1]
A Return to the Bad Old Days
Historically, Senator Obama's tax rate would be the highest
individual tax rate since the Jimmy Carter days. Tax shelters and
tax avoidance strategies were common when the top marginal rate was
70 percent or higher. This new top tax rate will again encourage
these gimmicks, reducing investment and economic growth as
resources are squandered in an attempt to avoid punitive
taxation.
Many individuals will attempt to transfer their compensation
from wages to capital gains, since capital gains would only be
taxed at 25 percent, or less than half of the top rate on wages.
This would put a great deal of pressure on a company to do anything
it could to make its stock quickly increase in value. Other
individuals would try to incorporate so they could pay business
taxes instead of having to pay taxes on their wages. Again, these
resources would be diverted away from more productive uses and slow
the economy.
High tax rates also encourage capital and income flight to
lower-taxed areas. There is ample evidence in the United States of
individuals and businesses moving to states such as Florida or
Delaware to take advantage of their tax-friendly laws. A higher
federal tax rate would encourage individuals to move assets abroad
to take advantage of lower tax rates in countries such as Canada,
France, and Great Britain.
These high tax rates could also have a large impact on the labor
force. Many workers could choose to reduce their hours or simply
retire in the face of such high taxation. Economists usually argue
a great deal about what effect minor changes in the tax code will
have on incentives to work. However, the Obama plan calls for a tax
increase so large that economists will be focusing on the harm to
the overall economy rather than just the isolated effects on labor
and on capital.
A Finite Source of Revenue
Perhaps a larger worry than the damage to the economy is the
long-run budget problem of the United States. While Senator Obama
raises taxes a great deal on upper income individuals, the overall
tax plan increases the national deficit. As a result, the country
will be even less prepared to pay for current and future Social
Security and Medicare obligations. When money is needed to pay for
those programs, it will be hard to tax the rich even more, given
that the top rate will already be so high. Instead, in order to pay
the government's spending and entitlement shortfalls, taxes would
fall most heavily on middle-income Americans. After all, even
successful taxpayers are not an infinite source of revenue.
Rea S.
Hederman, Jr., is a Senior Policy Analyst and the Assistant
Director, and Patrick Tyrrell is a Research Assistant, in the
Center for Data Analysis at The Heritage Foundation.