Modeling Martin O’Malley’s Idea for Tax Increases December 23, 2015 Alex Durante Alex Durante During Saturday’s CNN Democratic debate, Governor Martin O’Malley (D-MD) suggested creating a new tax bracket that would apply to income over $1,000,000, and taxing capital gains at ordinary marginal income tax rates. He claimed that these changes would provide sufficient revenue for the public investments he supports. Here is the relevant quote: “If we were to raise the marginal rate to 45% for people earning more than a $1,000,000, and if we taxed capital gains essentially the same we do earnings from hard work, sweat, and toil, you could generate $800 billion over the next 10 years, and that would do so much good for affordable college, debt-free college, cutting youth unemployment, investing in our cities again…” Governor O’Malley did not provide any additional details, but I think it would helpful to examine how a similar set of changes would impact government revenues. Using the Tax Foundation Taxes and Growth Model, I modeled the effects of adding a new bracket of 45% on income over $1,000,000 and taxing capital gains and dividends at ordinary income rates. I found that these changes would raise a considerable amount of revenue on a static basis, but substantially less on a dynamic basis. On a static basis, these changes would raise roughly $2 trillion over the next decade. However, these tax hikes sharply raise the cost of capital, leading to a decline in GDP of 4.2%. Accounting for this reduction in economic growth, they would generate $865 billion over the next decade. Table 1: Ten-Year Revenue Impact of Tax Changes (Billions of Dollars) Tax Static Revenue Impact (2015-2024) Dynamic Revenue Impact (2015-2024) Individual Income Taxes $2085 $1245 Payroll Taxes $0 -$312 Corporate Income Taxes $0 $6 Excise Taxes $0 -$27 Estate and Gift Taxes $0 -$11 Other $0 -$36 Total $2085 $865 Source: Tax Foundation Taxes and Growth Model, October 2015. Note: Individual items may not sum to total due to rounding. Distributionally, on a static basis these changes would reduce the after-tax incomes of the top 10% and top 1% of earners by 3.84% and 8.52% respectively. Other deciles would also see small reductions in their after-tax income, due to higher rates on investment income. On a dynamic basis, all income deciles would see reductions in their after-tax income as a consequence of the decline in GDP. Governor O’Malley is not the only Democratic candidate who has called for increasing taxes on wealthy individuals to pay for additional government spending. I find that eliminating the preferential treatment for capital income and imposing a higher tax rate on millionaires would raise a significant amount of revenue, but impose substantial burdens on economic growth and reduce after-tax incomes for most taxpayers. Table 2: Distributional Analysis for Tax Changes Effect of Tax Reform on After Tax Income Compared to Current Law All Returns by Decile Static Distributional Analysis Dynamic Distributional Analysis 0% to 10% 0.0% -3.94% 10% to 20% -0.01% -3.76% 20% to 30% -0.02% -3.77% 30% to 40% -0.05% -3.99% 40% to 50% -0.08% -4.22% 50% to 60% -0.11% -4.26% 60% to 70% -0.13% -4.23% 70% to 80% -0.16% -4.05% 80% to 90% -0.24% -4.02% 90% to 100% -3.84% -7.51% 99% to 100% -8.52% -12.05% TOTAL FOR ALL -1.67% -5.49% Source: Tax Foundation Taxes and Growth Model, October 2015 Stay informed on the tax policies impacting you. Subscribe to get insights from our trusted experts delivered straight to your inbox. Subscribe Share Tweet Share Email Topics Center for Economic Analysis Center for Federal Tax Policy Business Taxes Individual and Consumption Taxes Individual Capital Gains and Dividends Taxes Modeling Tax Proposals Tax and Economic Modeling