As the debt-ceiling debate escalates, U.S President Barack Obama says federal tax increases are necessary to close the U.S. budget deficit.
Although Republicans then said that tax hikes were "off the table," this statement is reminiscent of a toddler who threatens to hold his breath until he turns blue if you make him eat spinach.
Given that our elected leaders in Congress just can't seem to curb their spending addiction, the unpleasant reality is that some types of tax hikes are essentially inevitable.
Truth be told, I can show you three tax increases that should be enacted.
As a taxpayer, that statement will probably make you wince in anticipated pain.
But once I've made my case, I'm betting that the investor in you will agree that these three federal tax increases could save the U.S. economic recovery.
Let's take a look ...
If we ignore the debt-ceiling debate (and the Aug. 2 deadline for increasing the ceiling) for a minute, and just consider the health and welfare of the U.S. economy, we can see that there are a number of federal tax increases that would be highly counterproductive.
One example: boosting the corporate tax rate above 35%.
Except for Japan, the United States already has the highest corporate tax rate in the Organisation for Economic Co-operation and Development (OECD). Corporations don't pay much tax because they are able to keep profits overseas in tax-free jurisdictions and employ leasing and other tax breaks. It would make much more sense to lower the corporate tax rate - perhaps to 30% - and close many of the loopholes so that the "yield" (what's actually collected) is the same or perhaps even a little higher.
Similarly, it makes no sense to increase the 15% tax on dividend income. Dividends are paid by corporations out of their after-tax income. The levy on dividends - paid by the company's shareholders - means those companies actually suffer from a "double-taxation" rate of about 47%.
This encourages companies to fool around with stock options, repurchase agreements and with overpriced acquisitions, thus ripping off ordinary shareholders and reducing the economy's efficiency.
[mm-toolbar]The best system would be to make dividends fully tax-deductible at the corporate level - just like debt interest - and then tax them as ordinary income at the individual level. We would benefit as investors and shareholders, because it would put more money in our pocket. That would make us very hostile to tax shelters and other management gambits - which at the end of the day would very likely increase overall tax yields.
Increasing individual rates of income tax and capital gains tax is also economically inefficient, but less so.
The Laffer Curve is a way of demonstrating the relationship between government tax revenue and tax rates. According to Arthur Laffer, tax-rate increases decrease the taxes' yield below what you would expect.
That's a very important truth. But there's a bit of a catch.
In the Laffer Curve's extreme form, where you actually get less money when you increase tax rates, it's only true at very high rates.
At lower tax rates, the Laffer Curve is much less effective. The Laffer Curve effect for increasing capital-gains tax from 15% to 20% would be modest, reducing the additional revenue only slightly below that expected by simple proportionality arithmetic.
The Laffer Curve bends at lower rates for capital gains than it does for income tax: That's why the 35% capital-gains-tax rate of the 1970s appears to have yielded less than the 28% rate that succeeded it.
We saw a similar effect in 2001, when the top income tax rate was reduced from 39.6% to 35%. The Laffer Curve offsetting revenue gain was modest.
Since 2001, however, Congress has added a Medicare surtax, and from 2014 onward there's an additional 3.8% surtax on top investment incomes.
When you include state taxes (which have also risen in many cases), high-income taxpayers are now subject to a top rate of more than 50%. At that point, the Laffer Curve effect substantially reduces the additional income from tax rate increases, though it probably does not eliminate it altogether.
That means that restoring the pre-Bush administration (II) rates on top incomes will produce much less revenue than is being predicted by the computer models that Congress is using.
And it will mess up the economy, too.
There is no Laffer Curve effect from closing loopholes. As an extreme case, the Republicans would like to end $6 billion in annual subsidies for ethanol producers. That will produce substantial additional revenue, including revenue from gasoline taxes as oil refiners change the mix they sell to gas stations. It will also make the economy more efficient, not less, effectively reducing a wasteful farm subsidy.
The same applies to several "tax preferences" in the tax code for individuals. The largest of these are the tax deductions for state and local taxes, home-mortgage interest, charitable contributions, health-insurance premiums and pension contributions.
Of that group, the following three deductions could be eliminated - thereby serving as three tax increases that could help save the U.S. economy:
The other two deductions, although even more expensive, are I think justified:
So if you are frustrated by everything you're reading about the debt-ceiling debate, write your congressional representative, and tell him or her: If you must increase taxes, do it by cutting out the home-mortgage and charitable deductions, other "corporate welfare" loopholes and the tax exemption for municipal-bond interest.
These increases would actually help the economy, or at worst be neutral; other federal tax increases would be damaging to this feeble recovery - some of them hugely so.
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