President Obama has a revolt on his hands. This week, his former allies in the house turned on him. The Democratic caucus voted on Thursday to reject the Obama-McConnell tax compromise. Those in the far-left wing of the Democratic Party find the tax deal unacceptable. They have a problem with the estate tax provision that GOP members negotiated and the extension of current tax rates on high-income tax earners.
It is no wonder that House Democrats took a beating in November. The provisions that the Pelosi-led liberals want stripped from the bill are the only two Republican proposals in the deal. This was a compromise, not a liberal wish list like the 2009 economic stimulus boondoggle.
The estate tax provision that has the Democrats outraged would tax estates over $5 million at 35%. Most conservatives would have favored permanent repeal of the estate tax, but the GOP presumably negotiated the next best thing. The estate tax is an immoral tax that disproportionately hurts family farms and small business owners. Those with the largest estates simply hire attorneys and accountants to avoid or greatly reduce their estate tax liabilities. The liberals on the left never seem able to come to grips with the notion that high tax rates encourage tax avoidance.
This misunderstanding also explains their opposition to the extension of today’s tax rates on high-income earners. Changing the highest marginal tax rate has no sustainable impact on the amount of revenue that the Treasury collects as a percentage of GDP. High-income earners are the best equipped to avoid taxes. When you raise the highest marginal income tax rate, you simply increase the incentive to avoid taxable income. You also discourage economic activity, which depresses the level of GDP.
My chart below presents a more than five-decade history of personal federal income taxes as a share of GDP. The blue line is personal federal income tax receipts (excluding capital gains taxes) as a percentage of GDP. Personal federal tax receipts as a percentage of GDP have fluctuated in a narrow range over the last five decades. The average since 1954 has been 7.35%. The red line in my chart is the highest marginal income tax rate. The highest marginal income tax rate has been as high as 91% and as low as 28%. In 1954, the highest marginal income tax rate was 91%, and personal federal tax receipts amounted to 7% of GDP. In 1989, the highest marginal income tax rate was 28%, and personal federal tax receipts were about 7.4% of GDP. And in 2008, the highest marginal income tax rate was 35%, and personal federal tax receipts were 7.3% of GDP. Notice a pattern here? Of course you don’t, because there isn’t one. Raising tax rates on the richest Americans doesn’t generate a sustainable increase in tax revenue. Instead, higher marginal rates generate an increase in tax-avoidance schemes.
In return for giving the Republicans the estate tax provision and extending tax rates for high-income earners, Obama gained a one-year extension of unemployment benefits, a one-year extension of refundable tax credits, a payroll tax holiday, and accelerated depreciation for business investment. Obama’s proposals are nothing more than a backdoor Keynesian stimulus program, but avoiding what could have been a recovery-killing tax increase is worth the price.
The additional tax provisions added by the president are likely to give the economy a temporary shot in the arm next year, but the most potent stimulus will come from the greater certainty created by an extension of the current tax rates and new congressional leadership.
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