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Reason Foundation

Democrats May Switch Strategy on Tax Cuts

David Godow
November 15, 2010, 12:40pm

Despite the punishing electoral losses suffered by Democrats, congressional Democrats may continue to exclude higher-income taxpayers from their proposed extension of the Bush-era tax cuts. In fact, according to Politico's Mike Allen, Democratic strategists will turn the pressure up on Republicans by redefining tax brackets to shelter taxpayers making more than $250,000 from the impending reversion to higher, Clinton-era rates. Instead, the income threshold required to see higher tax rates in 2011 would rise to between $500,000 and $1 million.

This would be a sly political move, one which might politically outmaneuver Republicans as they prepare to take control of Congress. It would be simple, as Allen notes, to label opposition to this sort of a plan as literally defending "tax cuts for millionaires." The problem is in the economics. This new plan is just as likely as its predecessor to hurt the economy, sacrificing long-term growth for the satisfaction of sticking it to the rich while the middle-class is suffering.

As Scott Hodge notes in this op-ed, taxpayers making over $1 million account for the largest share (around 35 percent) of all private business income for pass-through enterprises, which include sole proprietorships, partnerships, and other traditional small businesses. A tax hike on the "richest" actually means hurting the most successful entrepreneurs and making it harder for them to continue to grow.

Targeting a narrower and narrower band of very rich taxpayers is also unlikely to drive long-term revenue stability. The income of the richest taxpayers, which relies more on capital gains and dividend payments, is naturally more volatile since it follows the state of the market more closely than the average worker's wages.

As newly-released IRS data parsed by the Tax Foundation shows, the gross income of the top 0.1 percent of taxpayers (those who made at least $1.8 million) sank by over $200 billion, a whopping 20 percent, between 2007 and 2008. By comparison, the gross income of those in the top 25-50 percent of the distribution decreased by less than 1 percent. As a result, income tax paid by the top 0.1 percent fell by about 15 percent, twice the reduction that the top 50 percent experienced.

The point here is not to defend or feel sorry for wealthy taxpayers who might face higher tax bills in 2011, it's that targeting them is likely to retard economic growth without providing a sustainable source of tax revenue in the future. Naturally, for legislators facing both a recession and debt level of historic magnitude, ensuring both economic health and revenue stability is doubtless of prime importance.


David Godow is Research Assistant


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