- The Washington Times - Wednesday, July 29, 2009

OPINION/ANALYSIS:

The United States needs a new income-tax amendment to the Constitution in order to impose fiscal discipline on the Congress and the president.

The amendment would impose a proportional tax on all taxpayers to finance all future government programs. Currently, politicians buy votes with costly programs that do not directly cost a majority of voting citizens any money. Politicians tell 80 percent of the voters in the bottom income quintiles that they will not have to pay for these programs. They tell the voters that they will finance the cost of these programs by taxing the richest 2 percent of the voters, who earn more than $250,000 a year.

Politicians mislead American taxpayers into thinking that they can get something for nothing.

In the current political dialogue, President Obama promised not to raise taxes on American families making less than $250,000 per year. He pledged to let the Bush tax cuts expire on the rich making more than $250,000 per year. This expiration will increase the highest marginal rate from 36 percent to 39.6 percent in 2011.

However, the prospect of higher taxes does not stop there. The health care bill before Congress proposes income-tax rates of up to 45 percent and an 8 percent payroll tax on businesses that do not provide health insurance. These increased taxes are part of a package to completely overhaul the nations health care system, in which 90 percent of Americans are covered and 84 percent are satisfied with their coverage. Would the dialogue be different if all Americans had to pay for this plan?

There is abundant commentary on the negative impact of highly progressive taxes on the economy. However, it is worth repeating its most salient points to emphasize its negative impact on the economy. When the government tries to soak the rich with higher taxes to pay for new programs, the middle and working classes inevitably get wet. The rich are ingenious in avoiding being soaked by higher taxes. Their accountants and tax lawyers work overtime figuring out ways to reduce actual taxes. However, even more importantly, the rich change their economic behavior as a result of higher taxes.

Rich professionals work fewer hours. You do not have to be rich to understand this. Why should a lawyer, doctor or investment banker work extra hours when more than half of his income goes to the government? (Yes, more than half if he lives in a high-tax state such as New York or California.) He might prefer to make enough to support his golf addiction and spend more time playing golf. These are among our most productive citizens deciding to work less and create less value for society.

Rich business owners and investors take fewer investment risks in the U.S. because the after-tax return on investment is reduced. They also transfer more capital abroad where the after-tax return is higher. A large portion of the income of the rich is generated from profits of small- and medium-sized businesses and from investments. In a high-tax environment, these businesses will find some of their more marginal ventures aren’t worth the risk or the effort. Business owners will contract these marginal operations, move them overseas or shut them down.

As a result of these rational responses to higher tax rates, the middle and working classes inevitably get soaked. The spray starts with jobs. U.S. businesses provide fewer jobs because the rich do not invest in their U.S.-based businesses. As a result of lower after-tax income, the rich have less money to spend on goods and services provided by middle-income and working Americans.

For example, the housekeeper and the gardener may have to find new jobs. There is less money spent at restaurants, clothing stores and the arts. The spray usually ends up soaking the working and middle classes with taxes to pay for deficits. These deficits are created because higher taxes on the rich provided less tax revenue than projected to cover higher government budgets.

Arguably, the most insidious feature of highly progressive tax rates lies in the moral hazard of encouraging government programs whose costs do not justify the benefits. When a voter does not have to pay for an expensive government program, he has little reason to examine the costs of the program. He may get a small benefit from the program, but if it cost him nothing, he does not have to assess whether the costs outweigh the benefits.

On the other hand, if the voter contributes to the costs of a government program through additional taxes, he is more likely to force his elected representative to justify the costs imposed on him by the new program.

If there were an income-tax amendment that required all voters to be taxed on new programs in proportion to their income, these voters would force their elected representatives to closely examine the costs and benefits of all new programs. There would be no free ride. Even if the new tax amendment permitted some degree of progressivity, there would be more accountability and fiscal responsibility imposed on Congress and the president.

There are a large number of potentially beneficial government social programs, including universal health care, infrastructure projects, environmental projects and education programs that many Americans would not oppose if they knew they do not have to contribute to the cost. These programs are very expensive, and they should be subject to a cost-benefit analysis by politicians and taxpayers. Undoubtedly, fewer Americans would support these programs if they had to bear the costs.

Under the current tax system, a liberal Congress and president can avoid the tough cost-benefit analysis and voter scrutiny by shifting the costs of these programs to the rich. Paraphrasing former British Prime Minister Margaret Thatcher, the problem with soaking the rich to pay for social programs is that pretty soon you run out of other peoples money. The rich may not mind paying a share of these programs if the benefits outweigh the costs, but it is neither fair nor reasonable to expect them to pay the entire cost so the politicians can buy the votes of non-taxpaying voters.

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