It looks like President Obama may appease Republicans who demand that their funders – the wealthiest Americans – continue to enjoy ultra-low tax rates. Caving in would be a disastrous mistake both politically and economically. Below I focus on the reasons that Obama should show some spine on this issue.
On tax cuts for the wealthy, as on every other issue, the right is dangerously wrong and fundamentally dishonest. Higher tax rates on the wealthy will stimulate the nearly moribund U.S. economy and more particularly lead to job growth. Successful small business owners (and big business ones too) get to choose how to disburse surplus monies that their businesses generate. The higher the marginal tax rate on incomes above a certain level the greater the disincentive to distribute excess cash to those whose incomes are at or above that level. So . . . what does the business owner do when confronted with a rise on the government’s bite on any take home pay above $250,000 a year? (S)he will be more likely to keep at least more of the excess business surplus in the business itself. Spending on capital improvements or employing more people or even raising wages are all ways that business people can keep assets out of the IRS’s way. And, last I checked, these activities, as opposed to purchasing shares in hedge funds, actually stimulate an economy .
Of course, the super-rich do buy more than securities and derivatives, they buy yachts, 3rd and 4th houses, Maseratis, and dine at Michelin 3-star restaurants. Higher tax rates on the highest income, will curtail some of this spending but since the wealthy save a far greater percentage of their income than anybody else does, incentivizing them through progressive tax policies to invest more in their own businesses will result in a boon to our ailing economy.
Cons say that if we tax the rich at a higher rate, say 39% a opposed to 35%, entrepeneurs and other talented people will have less of an incentive to build successful businesses. When closely or even distantly considered, this argument falls apart.
First, most entrepeneurs start businesses because they are creative and think they have a great idea not because of overweening cupidity. Warren Buffett and Bill Gates started Berkshire Hathaway and Microsoft when marginal tax rates were 91% and 70% respectively. They didn’t say to themselves, hmmm, maybe I better not outperform the market by 20% every year or build software that will power billions of computers since when my business takes off into the stratsophere, I’ll be taxed at a high rate. Elvis Presley didn’t decide not to put out hit singles because 50% of the profits went to Colonel Parker and, of the remainder, the U.S. government took over half. No, he recorded hits because that’s what musical geniuses do. Second, to the extent that the most successful entrepeneurs retain less of the profits that their ideas generate, they will have a greater financial incentive to keep creating. Third, history shows that low or non-existent income taxes do not result in a flowering of the entrepeneurial spirit. The superrich of 120 years ago used their extraordinary wealth and power to keep labor unorganized and desperate, to game the stock market, to buy politicians, and to prevent competitors from gaining a toehold. Sound familiar?