Politics & Policy

Brace for Backfire

The class-warfare tax strategy of the Democratic Congress is an economic, and political, loser.

Are Democrats in Congress moving forward with a redistributionist, soak-the-rich tax agenda? Recent press reports suggest they are, although in doing so they ignore some bitter lessons in recent tax history.

According to a front-page story in the April 23 Washington Post, congressional Democrats are crafting legislation that would “shift the burden of the hated alternative minimum tax (AMT) onto the shoulders of the nation’s richest households.” Specifically, the bill would exempt taxpayers earning under $200,000 from the AMT (about 98 percent of taxpayers), and reduce tax rates for those earning between $250,000 and $500,000. To make up for the billions in reduced revenue, however, the plan would increase taxes on households earning more than $500,000 by either raising the maximum AMT tax rates or initiating “other adjustments to the tax code,” which presumably could include increasing the top regular income-tax rate.

Rep. Paul Ryan (R., Wisc.) accurately described this plan as a “job killer,” one that would punish small-business entrepreneurs. According to the U.S. Treasury Department, two-thirds of the benefits from the reduction in the top marginal tax rate in 2003 went to small-business owners and other flow-through entities filing taxes as individuals. Raising the top tax rate would only reverse this positive economic trajectory.

Further, these tax-rate hikes would be especially damaging to entrepreneurial ventures, which are the wellspring of innovation and growth in our economy. On the other hand, according to a study by the Small Business Administration (SBA), reducing marginal income-tax rates increases entrepreneurial start-ups, decreases exits from entrepreneurship, and lengthens the duration of entrepreneurial ventures.

Specifically, for married tax filers, the SBA found that a marginal rate reduction of 1 percentage point on entrepreneurial income increases the probability of entrepreneurial entry by 2 percentage points and lengthens the duration of entrepreneurial activity by 44.8 percent. Conversely, raising the top marginal rate will reduce the probability of entrepreneurial starts and significantly shorten the duration of entrepreneurial activity.

The notion that higher marginal rates have no impact on incentives and growth has been discredited by the academic community. For example, a 1997 economic report by the Organization for Economic Co-operation and Development found that “the increase in the average (weighted) tax rate of about 10 percentage points over the past 35 years may have reduced OECD annual growth rates by about ½ percentage point.”

With compounding, this is a very powerful — and very negative — economic result. Yet while such academic findings are increasingly accepted around the world, they’re ignored in the policymaking circles of the U.S. Democratic party.

Economics aside, class-warfare tax policies have always backfired on their advocates.  For example, in 1988 the Democrat-controlled Congress passed a universal catastrophic health-insurance plan, which was financed by a surtax of 15 percent on upper-income seniors. In fact, the maximum tax of $1,600 per couple affected only 5 percent of the elderly. (Sound familiar?)  But to the surprise of the Democrats, senior citizens — even those not subject to the surtax — protested so strongly (seniors actually assaulted the car of Rep. Dan Rostenkowski, the chief sponsor of the law) that Congress voted to repeal the program and the surtax the following year.

In 1990, President George H.W. Bush broke his “Read My Lips: No New Taxes” pledge when he agreed to the demand for higher taxes as part of a budget deal with the Democrats to cut the deficit. The deal increased taxes on upper-income taxpayers by creating a new top tax rate of 31 percent, up from the 28 percent maximum rate under Ronald Reagan. It also raised the effective marginal rate by increasing the limit on income subject to the Medicare payroll tax from $53,400 to $125,000. By reducing after-tax returns, these tax-rate hikes may have prolonged and deepened the recession. But they also were a major contributing factor to President Bush’s failed re-election bid in 1992.

In 1993, President Bill Clinton and the Democratic Congress pushed though another significant tax increase aimed at upper-income earners. This legislation created a new 36 percent income-tax rate, increased the top marginal rate to 39.6 percent, raised the Social Security payroll-tax cap, and repealed the cap on Medicare payroll taxes. As it happens, the 1993 Clinton tax increase — which passed on the strength of the congressional Democratic vote — also raised the “hated” ATM rate from 24 percent to 26 percent on income up to $175,000, and 28 percent on income above that amount.

Once again, this soak-the-rich tax policy backfired politically. Republicans regained control of Congress in 1994 by opposing the Clinton tax increases and supporting tax relief. And it was the GOP-controlled Congress that approved a bill in 1999 to repeal the AMT on individuals, although the measure was vetoed by Clinton.

On the whole, the American people are not an envious sort who want to redistribute income away from the rich, since most dream of becoming rich themselves. They also fear that tax hikes aimed at the rich will eventually hit the middle class. A recent American Enterprise Institute report stated that while most people like the idea of the rich paying a higher percentage of taxes, most also believe that Americans should not pay more than 25 percent of their total income in taxes. Similarly, polls show that repeal of the death tax is supported by a large margin of Americans, even though most don’t think they will personally benefit from such a development.

In pushing to “fix” the AMT with a redistributionist approach, the Democrats ignore the lessons of tax history at their own political peril.

– Cesar Conda is a senior fellow at Freedom Works and an editorial advisory board member of International Economy Magazine. He is a volunteer policy advisor to the Mitt Romney presidential campaign.

Cesar Conda — Mr. Conda, formerly assistant for domestic policy to Vice President Cheney, is a founding principal of Navigators Global, a Washington, D.C.–based public-affairs firm.

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