Obama Budget, Health Care Surtax Will Shrink Federal Income Tax Base

July 29, 2009

Federal Government Would Lose 40 Cents of Every Dollar Subject to Higher Tax Rates in 2011

Washington, DC, July 29, 2009 - With the expiration of the Bush tax cuts and the implementation of a proposed health care surtax, in 2011 the top federal individual income tax rate will rise to more than 46% and over 50% for those living in many states. This sharp increase in tax rates can be expected to reduce the size of the tax base and may raise substantially less revenue than the casual observer might think—perhaps only 60 cents on the dollar.

In Tax Foundation Fiscal Fact No. 182, "The Economic Cost of High Tax Rates," Senior Fellow Robert Carroll explains that for every 1% decrease in the after-tax reward from earning income—what taxpayers get to keep after paying taxes—taxpayers reduce their reported income by about 0.4%. The Fiscal Fact is available online at http://www.taxfoundation.org/legacy/show/24935.html.

"Obama's plan to raise the top tax rate from 35% to 39%, combined with the health care surtax, would mean top-earning households are keeping 17% less of their income after paying taxes," Carroll said. "Those earners can be expected to reduce their reported incomes by nearly 7%, resulting in a smaller tax base and less revenue for the government."

The high tax rates will also disproportionately harm small businesses and discourage entrepreneurialism. Carroll notes that roughly one-third of all business taxes are paid by owners of so-called "flow-through" businesses—sole proprietorships, partnerships and S-corporations—when they file individual income tax returns. About one-fourth of taxpayers hit by the higher tax rates derive at least 50 percent of their income from a flow-through business. Also, a substantial share of the new revenue—40 percent for the increase in the top two tax rates and 29 percent for the high-income surtax—can be attributed directly to the income reported for flow-through businesses by their owners.

"High tax rates have serious economic consequences," Carroll concluded. "They cause taxpayers to base decisions more on tax considerations and less on economic merit. They also shrink the size of the tax base, raise less revenue than some might think, and overly burden the entrepreneurial sector."

The Tax Foundation is a nonpartisan, nonprofit organization that has monitored fiscal policy at the federal, state and local levels since 1937. 


Fiscal Fact No. 182 is available online at http://www.taxfoundation.org/legacy/show/24935.html. To schedule an interview, please contact Natasha Altamirano, the Tax Foundation's Manager of Media Relations, at (202) 464-5102 or naltamirano@taxfoundation.org.

Follow Us

Tax Policy Blog

The official weblog of the Tax Foundation.


Tax By State

For information on your state, select it from the drop-down menu.


Ask a Tax Expert

Contact information for Tax Foundation policy staff Ask