This same dynamic drives the candidates’ business-tax proposals. President Obama proposes higher business taxes to pay for additional government spending, while Governor Romney proposes corporate-tax reform to make American workers and capital more productive.
Both candidates propose to both broaden the corporate income-tax base and lower corporate rates: If we reduce the economic distortions in corporate-income-tax policies, market forces will allocate capital and labor to better uses. Over time this will increase productivity and wages. Corporate-tax reform done right can expand the U.S. economy.
But President Obama is using corporate-tax reform in pursuit of a second goal: to raise revenue to finance future increases in government spending. This key difference means that most of the economic benefits of a less distorting corporate-income-tax code will be outweighed by the drag from higher total corporate taxation.
Worse, he wants to impose a higher tax rate on the small-business owners who are the linchpin of economic growth. Most small-business owners pay taxes the same way that individual taxpayers do, so if tax increases on the rich are allowed to take effect on January 1, those increases will also apply to successful small-business owners. If a reelected President Obama can use his veto pen to force increases in the top income-tax rates, he won’t be hiking taxes only on Wall Street bankers and billionaire investors — he’ll also be punishing your favorite successful restaurant, florist shop, hardware store, and dry cleaner.
President Obama’s team points out that only a small fraction of small-business owners now pay taxes at the top marginal rates. They neglect to mention that this small fraction is also responsible for most small-business hiring. Successful small businesses are crucial to their communities.
A recent study by economists Robert Carroll and Gerald Prante concluded that President Obama’s tax increases would raise the marginal effective tax rate on small-business investment by more than 15 percent. The long-term effects of his tax policies would be even worse: Annually, American economic output would fall by about $200 billion, and real after-tax wages would fall by almost 2 percent.
Ignored by the Obama approach is that tax increases create a disincentive to economic growth. The Romney approach, in contrast, is based on the belief that incentives affect behavior.
President Obama struck a nerve when he told small-business owners, “You didn’t build that.” In other contexts he has stressed the importance of luck to success in the marketplace. The rich, he says, are successful because they are “blessed” and “fortunate” (that is, lucky), not because they worked harder or smarter than their competition. In the Obama approach, success is given to you, not earned by you. And if one believes that economic success is not the result of effort, then it is a small step to conclude that raising taxes on work and investment will not significantly reduce the size of the economic pie.
Governor Romney’s approach — lowering marginal tax rates and preventing rate increases on work and investment — is grounded in a belief that incentives matter, that they affect behavior, and that economic growth and success derive largely from effort, ingenuity, and risk-taking. If you tax something, you will get less of it, and if you raise taxes, you’ll get less yet. President Obama’s tax policy doesn’t acknowledge this; Governor Romney’s does.
– Mr. Hennessey served as assistant to the president for economic policy and as director of the National Economic Council under President George W. Bush. He is a research fellow at the Hoover Institution.