Who Really Pays When You Soak the Rich?

Yes, I believe later on there should be tax increases. Speaking personally, I think there are a lot of very rich people out there whom we can tax at a point down the road and recover some of this money.

--Rep. Barney Frank on CNBC's "Closing Bell," 10/20/08)

Don't let the class warfare jargon fool you, this is not good news. Why? Because the Democratic plan will harm small business owners who have their business income reported on their personal taxes and two, there is no way for them to “cut taxes on 95% of American taxpayers” and only raise the rates on the top 5% and still keep all their promises. That is, assuming they intend on keeping those promises in the first place. Keeping fiscal promises is not a Democratic Party strong suit. Consider this analysis by the nonpartisan Tax Foundation:

  • To the surprise of some, even though Senator Obama's tax plan lowers taxes for the bottom four quintiles, marginal tax rates would fall only for the very lowest-income couples. Taking both income and payroll taxes into account, those at the very bottom of the income distribution would see their effective marginal tax rates fall from 27.4 percent to minus 58.6 percent due to proposed changes to the earned income tax credit and Senator Obama's new "Making Work Pay" credit.

  • [Under Obama's plan] Most low- and moderate-income couples would see their effective marginal tax rates rise, in some cases, significantly. Indeed, some low- and moderate-income taxpayers will see their marginal rates rise to more than 50 percent.

  • High-income taxpayers can also expect their effective marginal tax rates to rise—to 47.2 percent-under Senator Obama's tax plan. This increase is caused by rolling back the 2001 and 2003 reductions in the top two tax rates, curtailing deductions and exemptions at high income levels, and potentially raising Social Security taxes.

  • Senator McCain's tax plan also changes marginal tax rates. His proposal to replace the exclusion for employer-based health insurance with a new health tax credit boosts taxpayers' taxable incomes by their health insurance premiums which generally pushes taxpayers into higher tax brackets, but not to as great an extent as Senator Obama's tax plan.

How is it that low and moderate income Americans—hardly the rich—can see their tax rates rise? You can blame the labyrinthine ins and outs and amazing fiscal sophistry that is the US Tax Code. The mechanics of all, however, are far less important than the anticipated outcome—more tax dollars taken from productive Americans and “spread around” by Washington politicians who have already proven that they cannot be trusted with the nation's finances. They are looking forward to it, as Barney Frank, one of the architects of the current economic crisis said, there are a lot of rich people we can tax. For those of you in the lower and middle income brackets, congratulations, you have finally made it!

The Effect on Small Business

One of the major effects that all this tax mania will have is actually already being felt thanks to the economic problems we are facing: Venture capitalists are becoming more and more leery of investing in new businesses.

According to Associated Press (AP) business writer Michael Liedtke, “As it becomes increasingly difficult to cash out of their previous investments, venture capitalists are gradually closing their financial spigots in what could be the start of a long, dry spell for entrepreneurs.” Given the economic climate, the venture capitalists that are active are spending more of their money on the firms they have already committed to, rather than taking on new firms, and that can spell trouble for start-ups. “Companies soliciting their first round of financing raised $1.5 billion in the third quarter, down from $1.9 billion at the same time last year. To make matters worse for entrepreneurs, the credit crunch and slumping real estate market is closing financing options outside the venture capital industry. When entrepreneurs are looking to raise their first $1 million, they often rely on credit cards and home equity loans, but beleaguered banks have been imposing more restrictions on those sources.”

In other words, entrepreneurs are finding more and more avenues to seed money being closed off or seriously curtailed. Additional taxation on people who found businesses and so create jobs will have the effect of dampening the willingness and/or ability of venture capitalists to take the risks associated with investing in a new start-up business, and risk is really the name of the game. Venture capitalists rely on successes to offset the costs of inevitable failure. That is how they stay in business. By increasing their tax burdens, you make that risk far less acceptable and so it will be more difficult for new businesses to get off the ground. That slows the engine of job growth even further (and it is barely idling right now) and from there things get bad in a business climate that is already suffering.

The Bottom Line

It is simple: High taxes are bad for all business. “Soak the rich” tax policy is bad for entrepreneurs, especially those with start-up businesses that have to rely on venture capital. We have to inject capital into the economy, not into the Treasury and that is done by making the US a good place to do business, and that is done by keeping taxes low. In a free market economy, this is how it works and this has always been how it worked. It is as predictable as gravity and just as reliable. The alternative is the command economy of socialism, where economic decisions are in the hands of government, which takes most of your money to “spread it around.”

Thanks, I think I'll keep mine. Enough has been spread around already!