Millionaire’s Tax Will Hit Much More Than Millionaires

Millionaire’s Tax Will Hit Much More Than Millionaires
February 12, 2010

Supporters of health care reform need money—a lot of money—to pay for it. So it’s not surprising that they would try to get it from the people with the most money to spare. Hence the so-called millionaire’s tax embedded in the House health care bill.

As House Ways and Means Committee Chairman Rep. Charles Rangel (D-NY) explained, lawmakers are targeting big earners because it “causes the least amount of pain on the least amount of people.”

That’s the theory, anyway. In fact, the millionaire’s tax is a good example of how poorly some politicians understand the policies they propose.

The House and Senate have different versions of health care overhaul legislation, which has stalled because of the special election of Republican Scott Brown to replace the late Senator Ted Kennedy of Massachusetts. But shortly after Brown’s January election victory, House Speaker Nancy Pelosi (D-California) pledged to continue working toward a health care overhaul.

Starts at Half Million
The health care bill the House narrowly approved in November included a 5.4 percent tax on any portion of gross income (which includes capital gains and dividends) exceeding $500,000 for individuals and $1 million for a couple. The surtax would apply to tax years that begin after December 31, 2010. So the first sign the tax will hit more than millionaires is that it targets half-millionaires from the get-go.

The idea’s main selling point is that the increase would hit only 0.3 percent of tax filers —roughly 400,000 people—yet would raise $460.5 billion over the next 10 years. Congress’ Joint Committee on Taxation estimated the new tax rate would affect only 1.2 percent of relatively small business owners. But because the tax isn’t indexed for inflation, over time it would apply to more taxpayers as inflation affects income levels.

This is how the alternative minimum tax (AMT) became such a nightmare. The AMT was created in 1969 to prevent just 155 wealthy taxpayers from using deductions and credits to avoid paying any federal income taxes. Because it was not indexed for inflation, it came to affect an ever-growing share of the population, prompting Congress to pass a patch each year limiting its reach. Next year, without the patch, it is projected to strike 27.4 million Americans—nearly 20 percent of the country’s taxpayers.

The same process would happen with the millionaire tax. According to the Tax Policy Center, a joint venture of the Urban Institute and the Brookings Institution (not exactly anti-tax organizations), by 2019 the number of taxpayers subjected to the health care bill’s tax will have doubled. If inflation hits harder than the center’s analysts assume, the number will be even higher.
 
Small Businesses As Individuals
Out of the 300,000 or so joint tax filers earning more than $1 million, about 90 percent have small-business income. That’s because 75 percent of America’s small businesses are structured as pass-through entities and pay their business taxes at the individual level. So the $1 million isn’t going into those individuals’ pockets; it’s money they use to run their businesses.

To avoid the new tax, those businesses would have to adopt a new structure and start paying the complicated corporate income tax.

The top tax rate on business owners who pay taxes as individuals, as opposed to corporations, is now 35 percent. It is already scheduled to rise to 39.6 percent on January 1, 2011, and under the House bill it would rise even higher, to 45 percent on taxable income of $500,000 for singles, $1 million for couples. With state taxes, some combined rates could exceed 55 percent.

Vanishing Millionaires
In 2008, Maryland created a millionaire bracket subject to a 6.25 percent tax. When added to other state and local taxes, Marylanders could be hit with rates as high as 9.45 percent.

One year later, a third of the state’s millionaires had disappeared from Maryland tax rolls. According to The Wall Street Journal, about 2,000 $1 million-plus income tax returns were filed by the end of April 2009, down from 3,000 in April 2008.

Where did these millionaires go? Most likely to a state with no millionaire tax, such as neighboring Virginia.

Shrinking Economy
Would the same thing happen if the millionaire tax went federal? It isn’t clear, the University of Michigan economist Joel B. Slemrod said in his 2000 book Does Atlas Shrug?
 
It’s harder to move to another country than to another state within the same country. What’s more, the U.S. tax code is extremely punitive toward wealthy taxpayers who move abroad. The United States is one of the few countries in the world that taxes its high-earning citizens on their income regardless of where they earn it or where they live.
 
Council of Economic Advisers Chairwoman Christina Romer is more pessimistic, or at least was. In a 2007 article written with her economist husband David, she concluded tax changes—on millionaires or anyone else—“have very large effects: an exogenous tax increase of 1 percent of GDP lowers real GDP by roughly 2 to 3 percent.”

In other words, when you raise taxes, the economy shrinks.

Veronique de Rugy (vderugy@gmu.edu) is an economist at the Mercatus Center at George Mason University and a columnist for Reason magazine (http://www.reason.com), where an earlier version of this article appeared. Used with permission.