Would raising taxes on the rich help or hurt the economy?

September 8, 2010
Would raising taxes on the rich help or hurt the economy?
By Kevin G. Hall | McClatchy Newspapers

WASHINGTON — Raising taxes on the wealthiest Americans, as President Barack Obama proposes to do, probably wouldn't wreck the moribund U.S. economy, but extending the tax cuts they've enjoyed since 2001 could spur some economic benefit.

A healthy dose of "it depends" is needed when assessing the economic merits of whether to collect more taxes from the rich.

Congress returns next week to begin debating whether to extend some or all of the tax cuts from 2001 and 2003 legislation that President George W. Bush signed into law. These temporary reductions in income, capital-gains and investment-dividend taxes are to return to the previous rates unless Congress extends them by year's end.

Obama called again Wednesday to extend the tax cuts for all but the wealthiest 2 percent of taxpayers. He'd let the tax rate rise for single taxpayers with adjusted gross income above $200,000 and couples over $250,000. The higher rate would apply only to their earnings over those thresholds.

Republicans warn of disaster if all the tax reductions aren't extended. Some Democrats in Congress appear increasingly wary of the administration's approach, especially with prominent economists calling for a two-year extension for all the tax cuts, because they say the economy's too weak to raise taxes on anyone yet.

Bush's tax reductions temporarily created six income tax brackets — at 10, 15, 25, 28, 33 and 35 percent. If not extended, they'd revert to brackets of 15, 28, 31, 36 and, for those who earn more than $382,650 next year, 39.6 percent.

The Treasury Department estimates that extending all the tax cuts would deny the Treasury almost $3.7 trillion in revenues over the next decade, swelling the national debt. However, allowing the reductions for the wealthiest 2 percent to expire would narrow that loss to just under $3 trillion by raising $679.6 billion in new revenue from the wealthy, the Treasury estimates.

By the president's reckoning, a modest bump in the top tax bracket isn't going to harm the rich or the economy, since that was the rate that was in effect during the booming 1990s, the longest sustained economic expansion in U.S. history.

Republicans counter that the rich play an outsized role in the nation's economic life, and that raising taxes on them would weaken overall demand for goods and services, and could even tip the weak economy back into recession.

Who's right?

Some prominent analysts such as Mark Zandi, the chief economist for forecaster Moody's Analytics, are calling on Obama to back off his tax-the-rich proposal. He's no reflexive opponent of the president's; Zandi's praised Obama's 2009 stimulus as effective in sparking today's weak recovery after the economy's near-collapse. However, he doesn't think this latest proposal is well-timed.

"I think that given the very fragile recovery, policymakers shouldn't take any chances. In all likelihood the recovery would remain intact ... but I think there is enough uncertainty and fragility that it would be prudent not to raise anyone's taxes in 2011," Zandi said in an interview.

He stresses that reverting to higher tax rates to help reduce soaring federal budget deficits will be appropriate later.

"I do think it's reasonable to raise the rates on those upper-income households in 2012 and 2013," he said.

Obama's own former budget director, Peter Orszag, wrote a widely noted essay this week calling on the president to extend all the tax cuts for two years to provide a more hospitable business climate, and then to let them all expire, because that's essential to reducing the spiraling national debt.

"Higher taxes now would crimp consumer spending, further depressing the already inadequate demand for what firms are capable of producing at full tilt," Orszag wrote. "And since financial markets don't seem at the moment to view the budget deficit as a problem ... there is little reason not to extend the tax cuts temporarily."

Then after two years, let them expire, he said, because "over the medium term, the tax cuts are simply not affordable. . . . (A)s the economy recovers, the dominant problem will move from depressed demand to excessive budget deficits."

Other analysts say the evidence of the effects of raising taxes on the rich cuts both ways.

"I think the evidence we have is too imprecise to be able to say with confidence exactly what impact that's going to have on aggregate demand," said Karen Dynan, a veteran Federal Reserve economist who's now with The Brookings Institution, a center-left policy research organization.

During nearly two decades at the Fed, Dynan researched consumption and savings behavior. Although she thinks there's insufficient data to say how the rich might spend money they'd otherwise pay in taxes, there's data to show they save a higher percentage of their incomes than most people do. Some studies suggest that the wealthiest 5 percent of taxpayers save more than 40 percent of their incomes.

A 2000 study Dynan did for the Fed suggested that the rich save more of their incomes than other people do, so extending their tax cuts wouldn't spur as much economic activity as tax reductions for the less wealthy would.

That doesn't necessarily mean that raising taxes on the rich would boost the economy, however.

"It depends on what you are going to do with the money," Dynan said. "If the money goes back to small businesses, the unemployed, then I think it's likely to stimulate aggregate demand. If you use it to pay down the deficit ... it would be a negative" in stimulating demand for goods and services.

Economists generally agree that spending on unemployment benefits or aid to state governments filters back into the economy quickly, and thus has a stimulating effect.

That's why some analysts say that if stimulus is the goal, there are better ways to do it than extending tax breaks for the rich.

"Higher-income folks tend to spend relatively less and save relatively more. So in a classic view of demand-side stimulus, additional resources (for them) would have less bang for the buck than for doing the same thing for folks with middle and lower incomes," said Donald Marron, the director of the Tax Policy Center, a centrist policy research group.

A former Bush administration economic adviser, Marron said the rich would seek to evade higher taxes.

"At the very high end, you have the people who are the best at doing accounting and legal maneuvers to move income around," he said. The wealthy would sell property and stocks to get the lower tax rate on capital gains before it expires, he said.

ON THE WEB

Tax Policy Center statistics

Federal Reserve study on savings by rich


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