Posts Tagged ‘Tax Reality Series’

The Reality of Raising Taxes at the Top, Part 6: How to Raise Taxes at the Top Consistent with Economic Growth?

May 2, 2012 at 11:03 am

This blog series and our new report have shown that tax increases on high-income people of the magnitude under consideration would not change their behavior in ways that would hurt economic growth.  Moreover, the revenues from tax increases can reduce the deficit or fund investments that support growth.  So how should policymakers consider raising taxes at the top?

One way is to scale back inefficient tax expenditures.  Tax expenditures, such as the home-mortgage interest deduction, are essentially spending subsidies delivered through the tax code.  Any serious attempt to reform tax expenditures would affect high-income taxpayers, because they benefit more from the tax breaks than low- and moderate-income taxpayers do.

Broadening the tax base by reforming tax expenditures could increase the efficiency of the tax code by reducing opportunities for tax avoidance.  For that reason, we should aim for the broadest base and lowest rate possible to raise the revenues we need.  That doesn’t mean, however, that marginal rate increases for high-income taxpayers should be off the table, nor that the revenues generated by base broadening should be used to finance tax rate cuts.  In fact, the evidence should point policymakers to consider both base broadening and tax rate increases, because:

  • There’s a limit to how much tax expenditure reform is possible. Many of the tax breaks meet important needs or are politically difficult to reform.
  • Base broadening reduces opportunities for tax avoidance.  That, in turn, reduces the economic cost of additional tax rate increases.
  • The economic cost of unsustainable government debt is much higher than the cost of modestly raising taxes at the top to help reduce the deficit.
  • Fairness matters. Without rate increases, low- and moderate-income people would likely bear a greater share of the deficit reduction burden through deeper cuts to programs or tax expenditures that benefit them.

Put simply, tax increases on high-income taxpayers of the sort under consideration would not hinder — and could even bolster — economic growth. With this in mind, policymakers should aim for a balanced deficit reduction package that shares the load through a mix of tax increases and spending cuts.

The Reality of Raising Taxes at the Top, Part 5: Can Tax Increases Help Economic Growth?

May 1, 2012 at 9:44 am

In this blog series, and in our new report, we’ve considered how raising taxes at the top might affect economic growth.  We’ve found no convincing evidence that raising taxes at the levels that policymakers are considering would negatively affect high-income people’s reporting of taxable income, the amount they work, their saving and investment, the health of small businesses, or the rate of entrepreneurship.  But what if we look directly at the relationship between taxes on high-income people and growth?

Taxes No Barrier to Economic GrowthHistory shows that higher taxes are compatible with economic growth and job creation: both grew more strongly following the Clinton income tax increases on the highest-income households than after the Bush tax cuts.

The Clinton-era tax rates and revenues enabled budget deficits to fall, increasing national saving and reducing the long-term costs of borrowing, and this may have enabled the private sector to increase investment in ways that improved growth.  Similarly, the Congressional Budget Office finds that letting the Bush tax cuts expire on schedule would strengthen long-term economic growth, if policymakers use the revenue to reduce deficits.

That’s critical: how the government uses the revenue generated by tax increases largely determines how the tax hikes affect growth. Cuts or increases to tax rates do affect behavior, Urban-Brookings Tax Policy Center co-Director William Gale told journalists during a conference call last week.  “[B]ut they also have effects on the deficits, and those deficits’ impact on growth can be far larger than the incentive effects that are created.” (You can listen to the call here.)  What’s more, the revenue from tax increases can fund — or prevent cuts to — investments in areas that support economic growth, such as infrastructure and education.

Tomorrow, in the final installment of this series, we’ll look at how policymakers might consider raising taxes at the top.

The Reality of Raising Taxes at the Top, Part 4: Would Tax Increases Affect Small Businesses and Entrepreneurship?

April 30, 2012 at 12:37 pm

This blog series looks at how tax increases at the top affect economic growth. Today, we test claims that raising taxes on high-income people would heavily and adversely affect small businesses and entrepreneurs.

The claims don’t hold up against the evidence, as our new paper explains. Consider, for example, a recent Treasury analysis that shows that only 2.5 percent of small business owners fall into the top two income tax brackets and that these owners receive less than one-third of small business income.

Even small business owners who would be affected by tax increases on high-income taxpayers would not likely reduce hiring or new investment.  As Tax Policy Center co-director William Gale has noted, small businesses’ effective income tax rate would likely be zero or negative, regardless of small changes in the marginal tax rates, for three reasons:

  • They can fully deduct their investment costs, bringing the effective tax rate on new investment to zero, regardless of the statutory rate.
  • If they use debt to finance the investment, the interest payments would be tax deductible, making the effective tax rate negative.
  • They can fully deduct wage payments, so the marginal tax rate should have minimal impact on hiring.

New data show that young, startup companies — not small businesses generally — create disproportionate numbers of new jobs. Additional research says that tax increases on high-income people don’t seem to discourage entrepreneurs from creating new companies.

Findings on the link between income tax increases and business formation are mixed, but on balance they suggest that “higher tax rates are more likely to encourage, rather than discourage, self-employment,” according to the Congressional Research Service.  One reason why: taxes may reduce earnings volatility.  The government bears some of the risk of a new venture by allowing tax deductions for losses and, in return, it taxes the profits of successful businesses.

Next in this series: a direct look at the relationship between raising taxes at the top and economic growth.

The Reality of Raising Taxes at the Top, Part 3: Would Tax Increases Affect Savings and Investment?

April 27, 2012 at 3:02 pm

The second installment in this series on how tax increases at the top might affect economic growth noted that changes in tax rates don’t substantially affect high-income people’s decisions about how much to work.

Today, we’ll consider their potential impact on savings and investment.  Opponents say that raising the capital gains and dividend rates — which would primarily affect high-income taxpayers, since they receive most of the capital gains and dividend income — would discourage saving and investing, thereby slowing the economy.

But the research doesn’t support that claim, as our new paper explains.

Capital gains tax increases do reduce after-tax returns to saving, and this may cause some taxpayers to save and invest less. But, other people may save and invest more in order to reach a certain savings goal, balancing out those who scale back. On the whole, the Congressional Research Service (CRS) concludes that capital gains tax rate increases appear to have “little or no effect” on private saving.

This squares with billionaire investor Warren Buffett’s observation:

I have worked with investors for 60 years and I have yet to see anyone — not even when capital gains rates were 39.9 percent in 1976-77 [they are now 15 percent] — shy away from a sensible investment because of the tax rate on the potential gain.  People invest to make money, and potential taxes have never scared them off.

Moreover, what matters for economic growth is the impact of tax increases on national saving, or the sum of public and private saving.  If the federal government devotes the revenue generated by tax increases to reducing deficits (which represent public “dissaving”), the resulting increase in public saving is likely to more than offset any reduction in private saving.

That’s why the CRS concludes, “capital gains tax increases likely have a positive overall impact on national saving and investment.”

Looking for a link between capital gains tax rates and economic growth more directly, tax expert Professor Joel Slemrod concluded that “there is no evidence that links aggregate economic performance to capital gains tax rates.” Similarly, capital gains tax expert Len Burman has explained on his blog, and reiterated during a conference call for journalists earlier this week that “there’s no obvious relationship between capital gains, tax rates, and the rate of economic growth.”  (You can listen to the call here.)

As our paper discusses, there is also no sound evidence that increasing top income tax rates depresses saving or investment.

Our next installment will look at how tax increases at the top might affect small businesses and entrepreneurship.

The Reality of Raising Taxes at the Top, Part 2: Would Tax Increases Affect Work Effort?

April 26, 2012 at 1:15 pm

The first installment in this series on how tax increases at the top might affect economic growth explained that while high-income people reduce their taxable income in response to tax hikes, that’s more because they adopt tax avoidance strategies than because they work, save, or invest less.  Nevertheless, opponents of raising taxes at the top claim that doing so would discourage high-income taxpayers from working, and so harm the economy.

The evidence shows, however, that changes in tax rates don’t substantially affect high-income people’s decisions about how much to work.  As tax expert Len Burman recently told Congress, “Overall, evidence suggests [high-income Americans’] labor supply is insensitive to tax rates.”

Here’s why.  A marginal tax rate increase may encourage some taxpayers to work less because they will get to keep less of each dollar they earn.  But some people will choose to work more, in order to make as much money (after taxes) as they did before the tax increase.  The evidence suggests that these two opposing responses largely cancel each other out.

Some groups, such as married women and older workers, do respond to tax rate changes with big changes in their work hours, but that’s not true generally for those at the top.

Our next installment will look at how tax increases on high-income people might affect saving and investment.