When taxes on the rich rise, revenues fall - every time

Federal progressive income tax-rate structure.

Taxable income is the pot of wealth on which the federal government levies income taxes. Taxable income will be the net number on your tax return after deductions, such as your personal and dependency exemptions. Multiplied against this taxable income number are the federal tax-rate percentages. Our rate structure is progressive, in that the more taxable income one has, the higher marginal rate of taxation is imposed on the next upward layer of income.

For example, for 2008, married taxpayers were in the 10 percent rate bracket on taxable income up to $16,050, and were in the 15 percent bracket on taxable income from $15,650 to $65,100, and so on, until taxpayers rose to the 35 percent marginal tax bracket on taxable income in excess of roughly $350,000. It is this last group of taxpayers who approximate the top 1 percent of income taxpayers and constitute the super-rich taxpayers who purportedly have not been paying their "fair share."

The Bush tax cuts dropped the ordinary income rates for all taxpayers (40 percent to 35 percent for the top bracket just mentioned) and the capital gains rate from 20 percent to 15 percent. During the presidential campaign, President Barack Obama indicated that the Bush tax cuts would be rolled back immediately upon his taking office. Now the administration has decided to wait until Jan. 1, 2011, to implement the rollback (this is the date that the Bush tax cuts already were scheduled to expire, barring new enabling legislation to continue them).

The proposed rollback of the Bush tax cuts could push the ordinary rates back up for all income taxpayers, but the Obama administration has so far promised tax rate increases only for those with taxable income roughly between $200,000 and $350,000 (from 33 percent to 35 percent) and for the top bracket above roughly $350,000 (from 35 percent to 40 percent) and the capital gains rates for most taxpayers back up from 15 percent to 20 percent or higher (the president has suggested 25 percent).

What the data show.

Could the truth be that there is an inverse relationship between income tax rates and income tax revenues for the wealthiest taxpayers? That is, the higher the rates, the lower the revenues from this group, and vice versa?

Over the years, this premise has been vigorously challenged by the left, despite historical data that strongly suggest that it's true. A proper focus on only the income tax would note three major periods of significant income tax rate cuts prior to the Bush cuts: the Harding-Coolidge cuts in the mid-1920s, the Kennedy cuts in the early 1960s and the Reagan cuts in the 1980s.

The data from these periods plainly show significant increase in macro-economic growth: As marginal rates were cut, income tax revenues went up, not down, particularly in the top percentiles of taxpayers.

Did the Bush tax cuts have similar results? You would never know it from listening to the mainstream media "reporting," but until just a few fiscal quarters ago, federal revenues from income taxes were at an all-time high, again most markedly, when focusing on the richest top percentiles of taxpayers. According to a 2008 Wall Street Journal article based on 2007 Treasury Department numbers, the richest 1 percent of income-tax payers in 1990 paid 25 percent of the nation's income taxes. By 2005, the richest 1 percent paid 39 percent of the nation's income taxes. The numbers are even more astounding if we go back to 1980, prior to the Reagan tax cuts, when the top 1 percent of income taxpayers paid only 18 percent of total income taxes.

How can this be? President John F. Kennedy, in promoting his income tax cuts, noted the "paradox" of revenues going up as rates are cut. But it really is simple common sense. Significantly lowering marginal income tax rates stimulates people (particularly the most entrepreneurial) to create new and more wealth since there will be that much more left over after taxes.

Small business takes it on the chin.

The vast majority of small businesses in America are conducted as sole proprietorships, S corporations or partnership entities (such as general partnerships and limited liability companies). These "tax flow-through" entities have their profits taxed at the individual owner level.

Even if profits are retained within the business (as they frequently are) to fund working capital needs, the profits still are taxed at the owner level under the individual income tax rates that we have been talking about. What that means is that successful small businesses (the true engine of American entrepreneurism and job creation) frequently are thrown into the "rich" class and, on rolling back the Bush tax cuts, will suffer significant additional taxation.

That, in turn, will mean what it always means when a large additional cost of any kind is thrust upon American small businesses: a cutback in working capital, entrepreneurial wealth creation and employees.

Why?

If the facts so clearly show that lowering income tax rates on the rich increases the amount of dollars of income tax they pay, why would the administration and other revenue-hungry Democrats fight the premise so vigorously? Prior to the presidential election, we could have consulted an honest (ha, ha) political strategist to get the answer. He or she would have noted that arguing for upper-class tax rate cuts was not the way to gin up the average voter to vote Obama, whereas the opposite argument was.

Another reason is simple emotion and class warfare. During the primaries earlier in 2008, when newsman Charlie Gibson asked then-Sen. Obama about the phenomenon of capital gains revenues going way up when capital gains rates were cut, the senator seemed to acknowledge the fact, but concluded that if the rich got richer, the only "fair" thing to do would be to raise the tax rate on them.

These points should be heavily debated before the rates are jacked up. It's not that the rich aren't paying their fair share; they are, and then some, and have been paying progressively more dollars as a byproduct of creating more wealth. That's OK with middle-class me, because if we go in the other direction, people like me ultimately will be compelled to make up the shortfall directly, through increased middle-class taxation, or indirectly through even greater deficit spending.

Altieri is a professor of accounting at Kent State University, where he teaches advanced tax courses, and also special tax counsel to the law firm of Wickens Herzer Panza Cook and Batista in Avon.