Obama’s Tax Increase: The Economic Equivalent of Barbiturates

Today comes news that 20 percent of Americans are unemployed or underemployed, according to a Gallup Poll that queried ten times the number of households involved in the Bureau of Labor Statistics’ Household Survey. According to BLS numbers, 16 percent of Americans are unemployed or underemployed. We also had news that the number of new homes sold in January fell by 11 percent to the lowest level on record (below the lowest estimate of the 35 economists surveyed by Bloomberg News before the announcement). And yesterday the Conference Board reported that consumer confidence dropped by a remarkable 10 points to the lowest level in 10 months. So much for the consumer recovery: The only sector of the economy showing even a dead-cat bounce is manufacturing, but that’s just 15 percent of the workforce. These numbers were never exceeded, except at the trough of the Great Depression, when un- and under-employment was at 25 percent. And we just might get there.

The Obama administration has encountered the economic equivalent of a patient with low blood pressure, an erratic pulse, labored breathing, and a high fever. And it proposes to administer to this patient the economic equivalent of barbiturates. I refer to a proposed “Medicare tax” on capital income. The Wall Street Journal reports:

The White House’s new health-care proposal promises the “largest middle class tax cut for health care in history,” which is a creative way of describing a vast taxpayer-subsidized insurance entitlement. Naturally, the fine print goes on to describe one of the largest tax increases for health care in history, too.

This new ObamaCare bargain would for the first time apply the 2.9% Medicare payroll tax to “interest, dividends, annuities, royalties and rents,” so-called passive income that we are told includes capital gains, though the latter wasn’t explicitly mentioned in the proposal. This antigrowth investment tax would apply to singles earning more than $200,000 and joint filers over $250,000 and comes on top of the Senate’s 0.9-percentage-point increase in the payroll tax, which would bring the combined employee-employer share to 3.8%.

The rate hike on investment income would presumably take effect at the same time the 2001 and 2003 Bush tax cuts are due to expire next year, bringing the top rate to 22.9% as the current top capital gains rate would also rise to 20% from 15%. That’s a 52% jump, and the last time investors were slammed with anything comparable was 1986 when the capital gains rate bounced to 28% from 20%—or a 40% increase—as part of the Reagan tax reform that reduced income tax rates.

The only way to get a recovery is to get jobs. The only way to get jobs is to first have investment. The only way to get investment is to convince investors to shift money from their mattresses into risk. And the Obama administration is giving investors a giant disincentive to take risk. If you take risk, forgoing safe interest for a prospective capital gain, you might win or lose. If you lose, you can’t claim anything more than a token deduction. If you win, you give up a big chunk of your gains to the government. To take the risk, you have to assume that the likelihood of a gain is 15 percent greater than the likelihood of a loss, to take the present 15 percent capgains tax rate into account. Jack up the rate to 20 percent, and you destroy investors’ incentive to invest in the marginal project.

There’s no capital going to risk projects—venture capital investments fell by 50 percent during 2009. There’s plenty of money going into government-subsidized investments in recycled toxic waste securities, which kept bank profits going during 2009. And the Obama administration is going to make things that much worse.

Reuven Brenner and I proposed precisely the opposite in the December 2009 issue of First Things : eliminating all taxes on capital income and shifting the tax burden to consumption. That would provide incentives for investors to take the risks in brick-and-mortar investments that create jobs. What Obama proposes is toxic, as I warned on Larry Kudlow’s CNBC show Monday night.

It’s going to be a very, very long decade.