Economy & Budget

Democratic Myth No. 4: Folks like me should go back to the rates we paid under Clinton

Democratic Myth No. 4: Folks like me should go back to the rates we paid under Clinton

Editor’s Note: This analysis is the fourth in a five-part series on Democrats’ mythical sound bites by Andrew Puzder, an economic adviser to Mitt Romney and CEO of CKE Restaurants, which employs about 21,000 workers.  The third installment was entitled, “Democratic Myth No. 3: They Want to Return to Same Practices that Got Us into This Mess.” The second was “Democratic Myth No. 2: Those Who Have Done Well Should Pay Their Fair Share.” The first installment was “Democratic Myth No. 1: GOP Is to Blame for Failure of Obama’s Job Policies.”

When discussing the higher tax rates he claims successful people should pay, President Obama explains himself as follows: “So all I’m asking is that folks like me go back to the rates that we paid under Bill Clinton.”

It is difficult to say whether this mythical sound bite is an attempt to tether President Obama to a more successful president or an attempt to convince people of this president’s reasonableness in wanting to increase taxes on people who have been successful.  In either event, it is simply untrue.

President Obama’s proposed tax rates are not the same as those in place in the late 1990s.  Obamacare adds a number of new taxes that increase the rates on both earned and investment income well above those in place during the Clinton administration.

More importantly, President Clinton worked with a Republican Congress to lower taxes on capital gains, while President Obama proposes to increase them.  President Obama proposes doing so despite his acknowledgement that “[t]he last thing you want to do is raise taxes in the middle of a recession because that would suck up … take more demand out of the economy and put businesses in a further hole.”  Both the actual increase in tax rates and the direction of the change are important.  By lowering rates, President Clinton did exactly the opposite of what President Obama is doing.  The contrast between Presidents Clinton and Obama could not be clearer.

Above all else, Obamacare is a tax or, more appropriately, a series of growth-killing taxes.  Rightly or wrongly, the Supreme Court specifically upheld Obamacare’s constitutionality based on Congress’ ability to impose taxes and Obamacare more than lives up to the Supreme Court’s opinion.  Based on data from the Congressional Budget Office and the Joint Committee on Taxation, the Heritage Foundation determined that Obamacare contains 18 different tax increases totaling an estimated $830 billion over the next decade “with $36.3 billion hitting Americans in 2013 alone.”

Beginning in 2013, Obamacare mandates an increase in the health insurance (formerly Medicare) payroll tax from 2.9 percent to 3.8 percent for couples earning more than $250,000 per year, and for single filers earning more than $200,000. This tax will apply to both earned income (raising the rate 0.9 percent from the current 2.9 percent to 3.8 percent) and, for the first time, investment income (raising dividend and capital gains tax rates by the full 3.8 percent). This 3.8 percent tax on investment income is the most economically damaging Obamacare tax.  It will increase taxes $317.7 billion over the next decade.  That’s $317.7 billion put into the hands of government bureaucrats and taken out of the private sector, reducing growth capital and inhibiting job creation.

This 3.8 percent tax on capital gains income obviously did not exist during the Clinton administration. In fact, in 1997 President Clinton signed a bill that lowered the top capital gains tax rate from 28 percent to 20 percent.  Under President Obama’s plan, the capital gains tax rate will increase from its current 15 percent level to the 20 percent rate that was in place under President Clinton.  Directionally, President Obama wants to take capital gains rates up whereas President Clinton took them down.  However, because Obamacare adds the 3.8 percent health insurance tax, President Obama would further raise capital gains rates to 23.8 percent.  Clearly, President Obama is not just “asking folks like [himself to] go back to the rates that [they] paid under Bill Clinton.”

The situation with dividends is worse and has the potential to further diminish equity investments and economic growth.  During the Clinton administration, dividends were taxed as ordinary income.  Under President Obama’s plan, when the Bush tax cuts expire the top tax rate on dividends would increase from the current 15 percent to the highest marginal rate of 39.6 percent.   On top of this increase, Obamacare’s 3.8 percent health insurance tax would further raise the top tax rate on dividends to 43.4 percent.  That’s almost three times the current 15 percent rate.

As I noted in a prior article in this series, the tax on dividends is a double tax as the profits corporations use to pay shareholders dividends are taxed when the company earns them and when the shareholder receives them.  According to a May 2012 study by the independent accounting firm Ernst & Young, under President Obama’s plan, in 2013 the top integrated dividend tax rate on corporate earnings paid to shareholders as dividends will be a 68.5 percent, including corporate and individual taxes at the state and federal level. This crippling double tax distorts economic decisions, such as the allocation of investments between debt and equity, as it lowers the returns on equity investments, thereby making an equity investment in a business less desirable and depressing economic growth.

Obviously, the Obamacare health insurance tax will increase tax rates on people who have been successful well beyond what they were paying in the Clinton years.  This is particularly true for small businesses that have over 50 employees (the Obamacare minimum) and earn more than $250,000 per year.  Such businesses are generally organized as Sub-Chapter S corporations, LLCs, partnerships or sole proprietorships and are referred to as “flow through” entities. For tax purposes, these “flow through” entities run their profit through their owners’ individual tax returns.  Such businesses employ 54 percent of the private sector work force and pay 44 percent of federal business income taxes.  “Flow through” entities with more than 100 employees employ more than 20 million American workers.  In fact, despite Vice-President Biden’s comment in the recent debate that “97 percent of the small businesses in America … make less than $250,000,”the reality is that “small business owning families earning more than $250,000 per year employ 93 percent of the people working in small businesses.”

How will President Obama’s tax plan impact such “flow through” entities? Taking into consideration the 3.8 percent Obamacare health insurance tax, the increased tax rates on dividends and capital gains, the increase in tax rates to their Clinton-era levels, and the reinstatement of a limitation on itemized deductions for high income taxpayers that was phased out under the Bush Tax Cuts (the “Pease” provision), Ernst & Young estimated in a July 2012 study that, in 2013, “the top tax rate on ordinary income will rise from 35% in 2012 to 40.9%, the top tax rate on dividends will rise from 15% to 44.7% and the top tax rate on capital gains will rise from 15% to 24.7%.”  This study does not include the further impact of state income taxes, which in many states, can add significantly to these rates.  As noted earlier, President Obama once almost prophetically stated that such tax increases would “take more demand out of the economy and put businesses in a further hole.” That hole is about to get much deeper.  Some refer to it as a “Fiscal Cliff.”

Yet, the health insurance tax is not the only Obamacare tax that could increase taxes for “flow through” businesses.  These additional Obamacare taxes include:

  • An annual fee on health insurance providers based on each company’s share of the total market (beginning in 2014 and increasing taxes by an estimated $101.7 billion over the next decade);
  • A penalty to be paid by employers that fail to offer health coverage to their employees (beginning in 2014 and increasing taxes by an estimated $106 billion over the next decade);
  • A tax on individuals who fail to purchase health insurance (beginning in 2014 and increasing taxes by an estimated $55 billion over the next decade);
  • A limitation on the amount of pre-tax salary deferrals taxpayers can make into a healthcare flexible spending account to $2,500 per year.  (beginning in 2013 and increasing taxes by an estimated $24 billion over the next decade); and,
  • An increase in the percentage at which medical expenses must exceed adjusted gross income before taxpayers can take a deduction for such expenses from 7.5 percent to 10 percent (beginning in 2013 and increasing taxes by an estimated $18.7 billion over the next decade).

Obviously, as Jerry Lee Lewis might have said, there’s “a whole of taxing going on.”  It is difficult to overstate the impact of materially increasing tax rates on the people who, through their “flow through” entities, employ 93 percent of the employees in a segment of our economy that employs 54 percent of the private sector workforce.  President Obama is proposing hundreds of billions of dollars in new taxes and that money has to come from somewhere.  According to Ernst & Young’s July 2012 study, President Obama’s tax plan would raise taxes on 2.1 million business owners, jeopardize 710,000 jobs, result in a decline in gross domestic product of $200 billion, and reduce economy output by 1.3 percent. Even the most inexperienced and naive ideologue should know that this is the worst kind of economic policy.

In contrast, the Romney plan

Why do this?  If the object were to raise tax revenues, hardly anyone would argue against the proposition that incentivizing growth is the most effective way to do so when the economy is faltering.  Rather than a tax plan that may well tank our entire economy, how about one that incentivizes growth, increases tax revenues and taps into the American spirit releasing its dynamic entrepreneurial energies?  As it turns out, Mitt Romney is proposing just such a plan.

First, he proposes lowering all marginal rates 20 percent while limiting tax deductions and loopholes that allow high-income taxpayers to reduce their tax payments.  In this way, Gov. Romney’s plan would encourage individuals, including the 54 percent of small businesses that are organized as “flow through” entities, to earn the maximum amount of income they can in any given year as each additional dollar would be taxed at a lower marginal rate.  Under the current tax code and under President’s Obama’s proposal, once taxpayers utilize their deductions, every additional dollar they earn in a given year is then taxed at the highest marginal rate for their income category.  This can encourage individuals and businesses to simply work less or to invest less as their incremental earnings will be taxed at a very high rate.  In other words, the current system can punish increased earnings and investment.

President Obama’s plan would materially increase the punishment.  Gov. Romney’s plan, on the other hand, would encourage both earnings and investment resulting in jobs and higher tax revenues.

To further encourage investment and growth, Gov. Romney’s plan would eliminate taxes on interest, dividends and capital gains for taxpayers making less than $200,000 per year.  For taxpayers making more than $200,000 per year, his plan would maintain the current rates.  Governor Romney would solve the 3.8 percent health insurance tax on investment income issue by simply repealing ObamaCare.

Governor Romney’s plan also cuts the corporate tax rate to 25 percent to make the United States competitive internationally and would switch to a territorial tax system allowing American companies to bring earnings they are holding overseas into the United States without incurring an additional tax.  All of these policies are designed to encourage investment, job creation and economic growth.

Gov. Romney’s tax plan would make up for the potential revenue loss from lower rates in two ways.  First, by eliminating certain deductions (which specific deductions are to be eliminated or the extent to which they are eliminated is something his administration would have to negotiate with Congress).  Second, and most importantly, by the resulting growth from a tax policy that encourages investment and profit rather than punishing it.

Growth is truly the only way to materially increase tax revenues in a struggling economy.   An August 2012 study by Professor John Diamond of Rice University found that a tax reform plan consistent with the parameters of Governor Romney’s tax reform would create about 7 million new jobs over the next 10 years and increase economic growth by 5.4 percent over the next decade and 6.0 percent in the long-run.

Similarly, a study by Stephen Entin and William McBride of the Tax Foundation found that the Governor Romney’s tax plan would increase real GDP by 7.4 percent over 5 to 10 years and result in a 7 percent gain in after-tax income across every income group.

Contrary to yet another Democratic Myth that Governor Romney personally debunked in the first debate, his tax plan would incentivize economic growth without raising taxes on middle-income or low-income taxpayers.

Independent fact checkers have labeled as inaccurate President Obama’s repeated claim that Governor Romney’s tax plan calls for “a $5 trillion tax cut” (yet another Democratic Myth). FactCheck.org; The Associated Press.  The President’s own Deputy Campaign Manager, Stephanie Cutter, admitted on CNN that “it won’t be near $5 trillion.”  The President’s continued assertions to the contrary are more indicative of desperation politics than any reality based policy concerns.

The president’s desperation is well founded.  Martin Feldstein, Chairman of the Council of Economic Advisers under President Ronald Reagan and a professor at Harvard University stated that “[t]he Romney plan can reduce the current tax system’s distortions, increasing national income in the short run and economic growth in the years ahead. That was the key to the very successful Reagan tax cuts of 1986. It was also the tax-reform strategy embraced by the bipartisan Bowles-Simpson commission in 2010. And it could put the economy back on the right track in 2013.”

No matter how many times President Obama repeats the claim that he just wants successful people to “go back to the rates [they] paid under Bill Clinton,” it will not become true.  Repetition is no substitute for veracity.  This statement is simply a myth propagated for political purposes to obscure the devastatingly negative reality of the President’s ideologically based tax policy.  If our economy is to recover, if we are to release the dynamic energy of the American entrepreneurial system, if our children and grandchildren are to have the same opportunities we had, if we are to regain our economic liberty, now is the time to change policies and to change Presidents.

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