Obama's tax proposal could spur growth

Posted: September 21, 2011

"Higher taxes mean fewer jobs - it's that simple," presidential candidate Mitt Romney said earlier this week. Romney is one of many Republicans criticizing President Obama's newly proposed "Buffett rule," which would raise taxes on some wealthy Americans.

While it's true that the Buffett rule would increase taxes, a less understood fact is that it would lower marginal tax rates. And that could give business owners more incentive to create jobs.

The proposed rule states: "No household making over $1 million annually should pay a smaller share of its income in taxes than middle-class families pay." Details are still unclear, but suppose "middle-class families" pay 25 percent of their income in taxes, which is the marginal tax rate for many middle-income earners. If a "millionaire" already pays more than 25 percent of his income in taxes, the change won't affect him. But a millionaire whose income derives from both capital gains, taxed at just 15 percent, and business income, taxed at 35 percent, may well be paying less than 25 percent of his total income in taxes - and therefore would pay more under the Buffett rule.

But would such a millionaire have less incentive to create jobs? No, quite the contrary, because the Buffett rule lowers the marginal tax rate paid by the millionaires it affects, from 35 percent to 25 percent, even as it increases their total tax burden.

Consider, for example, a millionaire whose income consists of $1 million in capital gains and $100,000 from a chain of hot dog stands. This millionaire pays taxes of 15 percent on capital gains and 35 percent on net income from the hot dog stands, for a total of $185,000 ($150,000 plus $35,000.) This amounts to an average tax rate of 16.8 percent, less than the 25 percent marginal rate paid by many middle earners.

Under the Buffett rule, he would have to pay 25 percent of all income in taxes, for a total of $275,000. However, he would be keeping 75 cents of every additional dollar generated by the hot dog stands, compared with 65 cents of every dollar without the Buffett rule. So this millionaire would have more incentive to expand his hot dog business, hire more workers, and so on.

So, for the millionaires it would apply to, the Buffett rule would effectively cut marginal tax rates 10 percent even as it raises the overall tax burden. Compare this with the Bush tax cuts, which lowered the marginal tax rate on the highest earners by about 5 percent. Anyone who argues that eliminating the Bush tax cut for the highest earners will destroy jobs must therefore acknowledge that the Buffett rule would create jobs.

It's not clear whether extending the Bush tax cuts for the wealthy would have a significant effect on business investment and job creation. If not, the cuts should probably be allowed to expire as part of a broader package of measures to address our fiscal challenges, especially given today's historically low tax rates.

On the other hand, if Republicans are correct that eliminating the cuts would hurt job creation, there's a reasonable argument for their extension, at least temporarily. In that case, however, the Buffett rule would also boost job creation.

Either way, because the Buffett rule raises revenue while lowering marginal tax rates, it's exactly the sort of tax reform that economists - and Republicans - should be able to get behind.

David McAdams is an associate professor at Duke University's Fuqua School of Business.

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