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An Economic Loser in the Long Run

2 min readBy: William McBride

This op-ed was published in U.S.News & World Report on Dec. 2, 2011.

There has been more than the usual amount of rhetoric, noise, and confusion regarding the Senate Democrats’ bill that pairs a payroll taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. holiday with a permanent surtaxA surtax is an additional tax levied on top of an already existing business or individual tax and can have a flat or progressive rate structure. Surtaxes are typically enacted to fund a specific program or initiative, whereas revenue from broader-based taxes, like the individual income tax, typically cover a multitude of programs and services. on millionaires. This bill would make the tax code more complicated, more unstable from year to year, and more redistributive—all damaging to long-term economic growth.

It is essentially the 2012 version of cash for clunkers. Economists claim that the payroll taxA payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue. holiday would stimulate consumption spending, and it very well might in the short term. But just as cash for clunkers merely shifted car sales from the future into the present, this too will merely shift future consumption into 2012. We would basically be borrowing from ourselves and future generations.

This redistribution would occur not only across time and generations but also across income groups. The payroll holiday would cut taxes for one year on wages up to $106,800, while the surtax would be a permanent tax increase on millionaires.

The effect would be to increase the progressivity of our tax code, meaning high-income earners would pay an even greater share than they currently do. As it is, the top 1 percent of filers pay more in income taxes than the bottom 90 percent combined, giving us the most progressive income tax system in the industrialized world, according to the OECD.

There are real economic costs associated with such a progressive taxA progressive tax is one where the average tax burden increases with income. High-income families pay a disproportionate share of the tax burden, while low- and middle-income taxpayers shoulder a relatively small tax burden. system. First, high-income earners do a great deal of the saving, investing, entrepreneurship, and high-productivity labor necessary for economic growth. Second, the U.S. is unique in that most business income is actually taxed through the personal code, and a large share of that accrues to high-income earners—about 39 percent to millionaires, as does 18 percent of all small business income.

Lastly, economic growth is suffering right now in large part due to various uncertainties, including an exceptionally uncertain tax environment. Our tax code is in constant flux, which prevents long-term economic planning. There are some 65 so-called tax extenders due to expire at the end of this year, and the Bush-Obama tax cuts are due to expire next year, meaning the majority of our tax code is a perpetual political football. This bill only adds to these uncertainties.