FEULNER: The trouble with tax hikes

Reaching into the pockets of the rich also takes from the poor

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Want a surefire way to help the poor? Don’t increase taxes on the rich.

It sounds paradoxical. It also runs counter to what President Obama is telling Americans. He claims that raising taxes only on “the wealthy” (i.e., those making more than $250,000 a year) lets everyone else off scot-free.

This soak-the-rich tax scheme would wind up costing everyone something. In fact, in some ways the “non-rich” would be hurt worse than the wealthy.

The reason is simple: We live in an interconnected economy. The actions that affect one group wind up affecting all groups, for good or for ill. Who, for example, suffered more in the wake of the meltdown of 2008 - the “fat cats” whom so many love to pillory, or the small businesses that were shuttered after the moneyed investors and customers were unable to circulate as much money throughout the economy?

The same principle applies to tax policy. When we raise taxes on the rich, they react as any of us would: by doing what they can to shrink their taxable income. That means not investing as much in the kinds of projects that create jobs. This sets up a chain reaction: Lower-income workers wind up with fewer opportunities and smaller salaries - those fortunate enough to remain employed, that is.

The most accurate way to judge how a change in tax policy will affect income and revenue is to do what economists call a “dynamic” analysis. That simply means that when calculating the likely effects of a policy change, you account for how people will react to that change.

It’s common sense, really: Say you’re selling shirts for $20 apiece, and you sell 10 of them a day at that price. Total take: $200. If you double the price to $40, will you bring in $400? On paper, sure (using what economists call a “static” analysis) but not in real life. Some customers may pay the inflated price, but many others won’t. You’ll sell fewer shirts, and you’ll end up making less than before. Had you conducted a “dynamic” analysis ahead of time, you might have avoided this mistake.

So let’s apply this principle to tax policy. Using a dynamic approach to examine the proposed Obama tax increase, a new study by the Heritage Foundation found that all income quintiles in the economy would take a hit. (Actually, all get socked under a static analysis as well, but a dynamic analysis reveals just how bad it is.).

Take a household filing jointly, with no dependents, earning an adjusted gross income of about $130,000 in 2014. A static analysis of the Obama tax increase shows the household’s taxes would go up by an average of $1,440. Once you take into account the lower productivity we’d get economywide under such a tax increase, we find that the real income loss for this filer would be $2,700. That’s right: The tax bite would nearly double.

The same holds true for those with much smaller incomes. Someone with an average adjusted gross income of about $40,000 loses just $30 under a static scenario. But under a dynamic (read: realistic) analysis, the income loss jumps to $450 - 15 times greater. And let’s not forget that although the amounts involved for lower-income taxpayers is much smaller, they typically are far less able to absorb such losses than those who are better off.

The main casualties in the class warfare that tax hikers are waging are not the rich, but the poor and the middle class. By extending the tax cuts set to expire on Dec. 31, however, we can help all three groups - and put the economy in a better position to truly recover.

Ed Feulner is president of the Heritage Foundation (heritage.org).

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