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Saturday, June 21, 2008

The Coming Tax Bomb
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It is shocking to think that we have a presidential candidate who would make the private sector $5 poorer in order to make the government $1 richer.

That's economist Lawrence Lindsey's bottom-line assessment of Barack Obama's plan to raise the top marginal income tax rate and lift the cap on Social Security taxes. Obama's move would catapult the top marginal tax rate from 37.7% today all the way to 53% -- and that's before state and local income taxes.

Lindsey explains why raising top marginal tax rates yields little revenue but big downside distortions:

the economic well-being of the country is not measured by how much taxes the government can collect, or even the size of the deficit. Rather, it is measured by the country's productive capacity. Our theoretical entrepreneur's 11.2% decline in taxable income reflects both less effort on his part and a less efficient use of his income in order to avoid confiscatory tax rates. Or, to put it directly, Sen. Obama's plan would reduce an entrepreneur's after-tax profits by $70,000 - $56,000 in lost profits and $14,000 more in taxes - just to produce a net revenue gain to the government of $14,000.

But the tax hike story doesn't end there.

Obama has also proposed boosting the capital gains tax to 28%. Combine that with rising inflation, and you get a huge new tax on at-risk capital. Economist Michael Darda explains the risk to both the stock market and overall growth.

Capital gains taxes are set to rise to 20% from 15% in 2010 (with the dividend tax rate reverting to the top marginal income tax rate). Sen. Obama has proposed a bump in the capgains tax to 28% from 15%. A 28% capital gains tax, along with 4% headline inflation, would raise the effective tax rate on capital to 50% from 28%, and lower our model's stimulation of the forward P/E ratio to 12.1 from 15.3. This could cut the S&P 500 down by 15-20%, which would increase the cost of capital, lower the capital-to-labor ratio, retard trend productivity growth, and lower income and wage gains across the country. It simply makes no sense in this context. This is a significant risk looming over the market at a particularly inopportune time.

inflation tax 1.gif

Effective marginal tax rates on both income and capital gains could thus explode north of 50% in the next few years. In today's hyper-competitive supply-side world, we can't afford such an enormous leap backwards.

Or as Nobel prize winner Bob Mundell says, "I look upon the United States still as the main sparkplug of economic growth in the world." It thus follows, he says, that rescinding the Bush tax cuts "would be devastating to the world economy."

UPDATE: Don Luskin of Trend Macro makes another good point:

Worst of all, even the small contribution to Social Security solvency that Mr. Obama's plan might make is entirely illusory. In fact, the more taxes his plan collects, the worse Social Security's long-term situation gets. That's because all plans based on collecting taxes and saving them in the Social Security Trust Fund for future benefit payments rely on the U.S. government being able to redeem the Treasury bonds that trust fund holds.

There's only one place that the money to redeem those bonds can come from: taxes. So ironically, any tax dollars collected today will have to be collected all over again - plus interest. You like the idea of paying more taxes today for Mr. Obama's Social Security plan? Then just wait 20 years or so, because you'll get to pay more taxes all over again.

Obama's tax bomb is not the way to sustain America's fragile global lead in entrepreneurship and innovation.

posted by Bret Swanson @ 1:14 PM | Taxes

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Absolutely shocking, Bret!

Posted by: Berin Szoka at June 24, 2008 3:33 PM

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