Thursday, July 16, 2009

Small-business owners are warning that the economy would suffer under a health care bill proposed by House Democrats, which would drive tax rates for high-income taxpayers to levels not seen since before President Reagan’s tax reform of 1986.

The top federal income tax rate, which Mr. Reagan and a bipartisan Congress lowered from 50 percent to 28 percent, would reach 45 percent in 2011 if Congress and President Obama enact the surtaxes that are part of the health care reform plan that House Democrats announced Tuesday.

Small-business owners, who would take a direct hit from the surtaxes, expressed dismay over the proposal, saying it would force them to curtail hiring and reduce wages amid the worst recession in a generation.

“If they institute a 5 percent surtax on income, it will have a severe impact on small businesses that are already hurting,” said Michael Fredrich, whose Wisconsin company, MCM Composites, molds plastic parts.

“We run maybe three days a week, sometimes four days a week, sometimes zero days,” he said. “I can tell you that at some point, people … running a small business are just going to say, ‘To hell with it.’ ”

Not everybody is worried about the proposed tax’s impact on business.

“Most small businesses are small and would be completely unaffected by the surtax on high-income people,” said Chuck Marr, director of federal tax policy at the liberal Center on Budget and Policy Priorities (CBPP).

Polls show most Americans support raising taxes on the rich. However, the last time Democrats pursued that agenda in 1993, when they raised the top federal income tax rate from 31 percent to 39.6 percent, they lost their congressional majorities in both chambers the next year.

The current top federal income tax rate, established under President George W. Bush, is 35 percent.

Throughout his presidential campaign, Mr. Obama pledged to restore President Clinton’s top income tax rates of 36 percent and 39.6 percent. About 2.2 percent of filers with small-business income would be affected by this proposal to allow the top two marginal tax rates to return to pre-Bush levels after 2010, when the 2001 tax cuts are scheduled to expire, Mr. Marr said.

A new surtax of 5.4 percent in the health care bill, which would apply to married couples’ income above $1 million, would bring the top federal income tax rate to 45 percent.

After consideration of state and local income taxes and the Medicare payroll tax, which applies to all wage and salary income, taxpayers in 39 states would face a top marginal income tax rate of more than 50 percent, according to a study by the Tax Foundation, a nonprofit tax research group based in the District.

“That means government would be taking more than half of every additional dollar from high-income taxpayers,” said Tax Foundation President Scott Hodge. “The lowest tax rate would be 47 percent - and that’s in the nine states that don’t tax wages.”

Businesses say the surtax would hurt the economy.

“The intention of this plan is to tax high-income households, but the real victims would be America’s small-business owners,” said Thomas Donohue, president of the U.S. Chamber of Commerce. “Placing a big tax burden on the small-business community would rob them of the resources they need to create the jobs that will lead us out of the recession.”

Some small-business owners seemed to be counting on layoffs if the surtax is imposed.

“That tax is going to be paid for by something, that’s going to go right to jobs. That money has to be taken from the employer and given to the government,” said David Rhoa, whose Indiana company, Lake Michigan Mailers, is in the direct-mail business. “While I can’t speak for every employer, I can say that many of them are going to take that right from their payroll.”

Increased unemployment will be the result, he said.

Based on an average top marginal tax rate of 52 percent among all states, “the United States will have the highest marginal income tax rate in all but three countries of the Organization for Economic Cooperation and Development,” said Curtis Dubay, a tax analyst at the conservative Heritage Foundation.

“From the standpoint of global competition for capital, the new surtaxes would represent unilateral disarmament. For a lot of people, it means their wages won’t rise because the surtaxes will drive capital and investment away.”

The OECD is a group of 30 mostly high-income nations. Only Denmark, Sweden and Belgium would have higher top marginal rates, Mr. Dubay said.

By other measures, however, the United States is not overtaxed relative to other countries.

“The United States is and will remain a low-tax country,” said Mr. Marr.

When total taxes are measured as a percentage of gross domestic product, the United States has the fourth-lowest tax burden in the OECD, Mr. Marr said. He pointed out that most European countries raise much of their revenues from a national value-added tax. That tax provides significant funds to their public sectors, which are much larger than that of the U.S., he said.

“Capping itemized deductions [on high-income households],” which Mr. Obama proposed in his fiscal 2010 budget, “reforming the tax treatment of health care and [instituting] a surtax are all good options to help pay for health care reform,” Mr. Marr said. “Given the disproportionate income gains and tax cuts at the top end, a surtax on these same people is a logical option.”

The CBPP reported last year that average income gains, adjusted for inflation, increased by $321,132 between 2002 and 2006 for the top 1 percent of households. For the top 0.1 percent of households, average income gains exceeded $1.8 million during that four-year period.

In contrast, income gains for the bottom 90 percent of households averaged less than $1,500 between 2002 and 2006.

The CBPP’s calculations were based on a study by economists Thomas Piketty and Emmanuel Saez, who examined Internal Revenue Service data released last year. The share of total pre-tax income flowing to the top 1 percent has increased from about 8 percent in the early 1970s to 20 percent in 2006, the economists found.

While the share of income received by the top 1 percent has increased, so has its share of taxes. According to an April study by the Congressional Budget Office, the top 1 percent of households in 2006 paid 39.1 percent of individual federal income taxes, 57.1 percent of corporate income taxes and 28.3 percent of all federal taxes. In 1979, according to the CBO, the top 1 percent paid 18.3 percent of individual income tax liabilities and 15.4 percent of total federal taxes.

Health care-related surtaxes would begin at 1 percent for married couples earning $350,000 in adjusted gross income (and singles earning $280,000). The surtax would peak at 5.4 percent for married couples earning $1 million (and singles earning $800,000). The surtaxes are expected to raise $544 billion over 10 years.

“The top 1 percent of earners - those making more than about $550,000 - would pay on average almost $36,000 in extra tax,” estimates the Tax Policy Center, a joint venture of the Brookings Institution and the Urban Institute. “The top 0.1 percent of 1 percent - those earning more than $2.3 million - would have to [pay] an average of an additional $280,000, a cut in after-tax income of more than 5 percent.”

Overall, “barely 1 percent of taxpayers” would pay the surtax, the Tax Policy Center estimated.

Opinion polls indicate Americans favor taxing the rich rather than themselves, said Karlyn Bowman, a polling specialist at the American Enterprise Institute, a conservative think tank.

“The idea of taxing the rich is always popular,” said Ms. Bowman. People constantly tell pollsters the rich don’t pay enough in taxes, she said - about 60 percent supported Mr. Obama’s campaign pledge to raise taxes on couples earning more than $250,000.

“Nationally, the tax issue does not have near the intensity it had five to 10 years ago,” Ms. Bowman said. “Perhaps that’s because many people do not pay income taxes.”

“Nearly half of all families and individuals will pay no income tax this year,” said Bob Williams of the Tax Policy Center. “Among those with income between $40,000 and $50,000, for example, nearly three-fourths of joint filers, two-thirds of households with children and three-fifths of the elderly owe no [income] tax.”

The Tax Foundation estimates that 60 percent of families pay less than 5 percent of their total cash income in federal income tax.

• Katherine Timpf contributed to this report.

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