“Rich” People, Prepare to Get Soaked

07/20/2009 10:40 am EST

Focus: MARKETS

Terry Savage

Author, The Savage Truth on Money

It was just a year ago that candidates were falling all over themselves to promise that they wouldn’t raise taxes. What happened to all that bluster? If we’re going to have health care “reform,” it’s going to be paid for through higher taxes. And those taxes are likely to fall upon you!

The bottom 40% of income earners pays no federal income tax (although they do pay the FICA payroll tax for their future Social Security benefits). In fact, the bottom 40% of wage earners actually received net payments from the federal government, through programs like the earned income tax credit.

The “middle class”—defined as the middle 20% of income earners—pays only 4.4% of federal income tax revenues. Even if we doubled the tax rate on the “middle class,” it wouldn’t be enough to offset higher government spending on stimulus programs, not to mention health care reform. 

So, that leaves you. When it comes to taxes, you’re the “upper class”—the top 40% of taxpayers who do all the paying. And now, you’ll be paying more.

For purposes of this discussion—and of all the discussions on Capitol Hill—we have to forget that when you raise tax rates on smart people, they tend to change their behavior. That is, if Congress and the president really think they’ll collect more tax revenues by raising tax rates, they only have to look at history to see the folly of this assumption.

Surely, you will do some things differently if you see your last marginal dollar of income being taxed at 50%, or more. We haven’t heard the words “underground economy” in a long time, perhaps because tax rates were reasonable and most people didn’t take the time and make the effort to evade taxes. 

Most people don’t remember the words of President Kennedy, who cut the top tax rate from 91% to 70%. He said: “Paradoxically, the way to increase tax revenues is to cut tax rates.” But today’s elected officials persist in believing that Americans who are smart enough to make all that money are dumb enough to keep working and let their income be taxed away.

Peter Ferrara of the Institute for Policy Innovation (and a former White House aide to President Reagan) has proposed a radically different solution to our tax problem. He proposes a zero tax rate for the bottom 60% of earners! In exchange, they would no longer receive all those “refundable credits.” That proposal, says Ferrara, would actually be revenue-neutral—that is, it would produce the same revenues, but with far lower costs and much less bureaucratic paperwork. 

And for the remaining top 40% of income-earners, Ferrara proposes a flat 15% tax—something he also says would be revenue-neutral, if you take into account the fact that people do change their behavior to respond to incentives. That is, instead of hiding money or quitting work because of high tax rates, the most productive people would get incentives to work harder, start more businesses, and earn more money—because they could keep 85% of what they earn! The result of lower rates would be higher tax revenues. You can read more about Ferrara’s proposal at www.ipi.org.

But even if we agreed that a simpler and fairer system would be revenue neutral, we’re still far short of finding the additional money needed for the president’s proposed health care reform plan, much less balancing the overall federal budget.

And that brings us back to the great debate over whether if you raise tax rates high enough on those who earn the most income, you could actually collect “enough” money to pay for our spending.  What do you think? Please post a comment and join the conversation.

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