Letting the Tax Cuts Expire for Top Tax Brackets.

Ask every small business you know if they expect their profits to be more than a quarter million dollars this year. Most will likely say no.
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In Tuesday's New York Times Peter Orszag's article "One Nation, Two Deficits", suggests that all the Bush-era tax cuts be extended for two more years. His argument for the deadline is that we cannot afford to extend them permanently as that would make the future deficits too large.

But his reason for extending the tax cuts appears to be as much political as economic. He seems to be saying that this proposal would represent a compromise that both Democrats and Republicans might accept. In his speech Wednesday, the President opposes this and so do I.

Orszag's economic argument is in one sentence: "Higher taxes now would crimp consumer spending, further depressing the already inadequate demand for what firms are capable of producing at full tilt." Peter is a very good economist, but I think this statement could use some more analysis. What I present here is my contention that letting the marginal tax rates on income above $250,000 return to what they were in the year 2000 (as proposed by the President) is going to have no impact on consumer spending while reducing the deficit.

No impact on GDP
Under the President's proposal, someone who has a taxable income of $400,000 would have a drop of after tax income from $282,000 to $277,000. I know people who make this kind of money and I am absolutely positive that this change would have zero impact on what they spend.

Remember that the tax is only on taxable income, and people with incomes this size could easily have $100,000 in deductions of interest paid on the mortgages of their (often multiple) residences, and for property taxes on the same. And if they are generous, they have more deductions on gifts to charities. So we are probably talking about an increase in their taxes of less that one percent of their income.

As a percent of their wealth, it is even less. A fair estimate is that people with incomes of $400,000 would have wealth of two million dollars. If a million of that is in the stock market, their wealth went up $6,000 just today. This is more than the amount of the proposed increase in their annual taxes! Again, I forecast there will be no change in purchases by the people who have seen their wealth fall by one quarter of one percent over a year because of an increase in their taxes of $14 a day.

Total impact on reducing the national debt.
An increase in the tax on these earners can reduce the deficit dollar for dollar. Here is how. Most likely part of this wealth is in US government bonds, either directly or in the bank accounts they hold. When they need to pay an additional $5,000 in taxes, they can turn bonds worth that much into the Treasury. They get a check for $5,000 from the Treasury that can be turned around and give back to pay their taxes. The treasury owes $5,000 less in debt and I contend, there is no change in amount spent by wealthy consumers.

If you are worried about those who make considerably more than $400,000 annually, the proportions do not change much. I have made the same calculations for someone making 50 million dollars a year and the drop in his or her wealth would still be less that one percent for the year.

What about small businesses?
If a small business makes a net profit rate of ten percent after all expenses have been paid, we would think it is doing well. If that net profit were $400,000, then the business would have a gross sales of four million dollars. If another business has gross sales of eight million dollars and a net profit rate of five percent, this would mean the same net profit amount. The increase in the taxes of these two businesses would be $5,000. How many jobs do you think a business that grosses $10,000 to $20,000 a day will eliminate if their taxes go up by $14 a day?

Remember, the tax increase is only on profits that are more than $250,000. Ask every small business you know if they expect their profits to be more than a quarter million dollars this year. Most will likely say no. Then ask then if they think President Obama is going to raise their taxes. Unfortunately, most will say yes.

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