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Tax Hikes on the Rich Will Hurt the Recovery

David Godow
September 14, 2010, 8:57am

Supporters of President Obama’s refusal to extend the Bush-era tax policies have cloaked themselves in a mantle of fiscal responsibility, arguing that extending cuts, particularly for high-income earners, would increase the deficit and national debt. Treasury Secretary Timothy Geithner, for instance, asserts that extending these so-called tax cuts for the rich would require $700 billion in new borrowing over the next 10 years, and would “[add] significantly to an already unsustainable level of debt.” Other estimates suggest that the government would capture $650 billion to $900 billion in additional revenues by returning the marginal tax rates for the top two income tiers to Clinton-era levels.

Secretary Geithner is correct in principle that an additional $700 billion would help cut down the deficit, projected at $3.7 trillion over the next 10-years. However, we shouldn't be thinking of the expiration of the 2001 and 2003 tax cuts as a loss in revenue. Given the length of time the present day code has been in place, ending the tax cuts would be more like a tacit tax hike. But because the government (under the leadership of Presidents Bush and Obama) has overextended itself, it needs more revenues to bring the deficit into balance.

It is probably inevitable that taxes will eventually need to increase to deal with the deficit and debt problems, but timing is important. We have to remember that sucking some $70 billion a year out of the economy will discourage real, sustainable economic growth - the kind that the Administration's fiscal stimulus has failed to provide.

As politically unpopular a constituency as the wealthy may be, they fuel the consumption that is already helping to drive our nascent recovery. Data from the Bureau of Economic Analysis show that personal consumption expenditures have grown GDP at an annual rate of 1.2% since the second half of 2009.

As Moody’s chief economist Mark Zandi has noted, the rich account for a significantly outsized proportion of U.S. consumption. The top 5% of taxpayers account for 37% of all consumer outlays, while the bottom 80% make up 39.5%. Zandi, quoted in this NYT piece, argues that it was consumption by rich households that began to drive the economy out of recession last summer. The spending habits of wealthy consumers are less vulnerable to economic downturn, while many middle-class Americans remain concerned over losing their homes or jobs. Discouraging this burgeoning source of consumer demand is a dangerous prospect given the ongoing fragility of the recovery.

Moreover, the negative consequences of raising taxes for the rich go beyond affecting consumption. The non-profit Tax Foundation has estimated that the return of the top two income tax brackets to their Clinton-era levels would bring the government an additional $39 billion in revenue in 2011. However, the consequent rise in the tax bill of wealthy citizens would encourage them to work less and take less of their income as wages.

This means less productivity, fewer goods and services purchased, and less investment – it means potential economic activity that does not occur because of changes in behavior caused by higher taxes. Economists call this phenomenon the excess burden, or deadweight loss, of a tax. The Tax Foundation’s analysis, which can be found in its entirety here, estimates the excess burden’s cost to our recovering economy to be $26 billion in 2011 alone.

Secretary Geithner is right that we need to address our colossal debt problem, but a tax hike on the wealthy could choke off major drivers of economic growth. Punishing the wealthy may make for good politics during election season, but, like it or not, high income Americans are going to make a significant contribution to our return to economic normalcy. A truly fiscally responsible solution to the debt issue needs to include a serious re-examination of our spending habits and looming social insurance obligations, not a questionable tax hike that will harm our prospects for a quick recovery.


David Godow is Research Assistant


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