Dems Tax Plans Could Cut the Legs Out From Beneath Limping Recovery

Contrary to what Democrats would have you believe, it is simply not true that raising taxes is the only way out of our current deficit problems. At best higher taxes could unnecessarily harm the recovery by choking off business growth when other, more economically sound alternatives to reducing our deficits exist. At worst, large tax hikes could doom us to a prolonged crisis and possibly even a double-dip recession.

In order to illustrate this point, let’s look to the states.  The policies that are pursued in these “laboratories of democracy” can frequently offer insight into what types of public policies could prove successful on the national level.

Let’s start with Maryland.

In order to raise government revenues, in 2008, the state of Maryland created four new income tax brackets.  The highest marginal tax rate in the state was 6.25% on those making over $1 million.  This is, of course, precisely the type of tax that Liberals love – the ones that “soak the rich.”

What did this tax hike cause?  Was it increased government revenues?  I don’t think so.

As The Wall Street Journal reports:

[A]fter passing a millionaire surtax nearly one-third of Maryland’s millionaires had gone missing, thus contributing to a decline in state revenues. The politicians in Annapolis had said they’d collect $106 million by raising its income tax rate on millionaire households to 6.25% from 4.75%…

Well, the state comptroller’s office now has the final tax return data for 2008, the first year that the higher tax rates applied. The number of millionaire tax returns fell sharply to 5,529 from 7,898 in 2007, a 30% tumble. The taxes paid by rich filers fell by 22%, and instead of their payments increasing by $106 million, they fell by some $257 million.

How could this be?  Where did all those millionaire’s tax returns go?

A Bank of America Merrill Lynch analysis of federal tax return data on people who migrated from one state to another found that Maryland lost $1 billion of its net tax base in 2008 by residents moving to other states. That’s income that’s now being taxed and is financing services in Virginia, South Carolina and elsewhere.

The wealthy, who have the financial wherewithal and motivation to change their place of residence, moved out of the high-tax state of Maryland.  When faced with oppressive marginal tax rates, the millionaire’s of Maryland decided to relocate, costing Maryland hundreds of millions of dollars in tax revenue.

What insights do the disastrous tax policies of Maryland give us into what federal tax policy ought to be?

They illustrate the same principle that we saw in play in the John Kerry-yacht fiasco: that the wealthy find ways to avoid paying higher taxes, and that can greatly curb the revenue-generating effects of a tax increase.  While it may be true that the wealthy can’t easily change resident to avoid a federal tax increase, their reactions could seriously undermine our recovery.  To understand why take a look at the Laffer Curve.

The Laffer Curve argues that there is an optimum tax rate that increases the most government revenue. What is obvious is that if the tax rate is zero the government will receive no tax income. What is less clear is that when the individual tax rate reaches 100% there will also be no tax receipts. Why? Because if the government is going to take every penny you earn, there is absolutely no incentive to work.

Existing on the right hand side (the overtaxed side) of the optimum tax rate is a bad place for government to be. If these governments simply lowered rates their gross tax receipts would actually rise, a product of increased incentive to work by individuals in the society. There are examples of this throughout our history. Take the 1970s when the top marginal income tax rate was 70% – so high that it discouraged people from engaging people in productive behavior. By lowering tax rates, as Reagan did, the federal government was actually able to increase tax revenues.

In today’s slow economy the government must do everything it can to maximize productivity. This is because increased productivity by and large leads to more jobs being created which is what will be needed to escape the persistently high unemployment we find ourselves in.

Unfortunately, Democrats in Congress are tossing around the idea of a tax hike as the only means of escaping our debt crisis. In reality, a tax increase only disincentivizes productivity from our business sector. Chopping the legs out from beneath an already limping economic recovery is the worst thing we could be doing. Then again, I haven’t come to expect much more from this President or this Congress.

by Brandon Greife, Political Director of the College Republican National Committee