Economic Effects of Higher Taxes

As talks continue in the fiscal cliff negotiations, one scenario that’s been discussed is raising taxes on capital gains and dividends.  Currently, both capital gains and dividends are taxed at a rate of 15%.  But if President Obama and Democratic members of Congress get their way, rates for capital gains could go as high as 28%, with dividends taxed at the personal tax rate, which could go as high as 45%.

A new study just released by ACI shows that raising taxes on capital gains and dividends could have a devastating effect on the economy.  The study finds that the proposed increases would reduce capital investment and investment in factories and equipment.  All told, it could cost the economy 2 million jobs.  Although the economy seems to be making a slow recovery, it’s not creating nearly enough jobs to move the US economy back to where it needs to be.  And the loss of 2 million jobs would be a detriment to any hopes of a quicker recovery.

Slowed investment on the part of businesses isn’t the only worry with the potential increase in investment rates.  Although the hurt inflicted on economic growth and job creation should be on policymakers’ minds, they should remember the millions of American’s that rely on investments as their primary source of income.  We’re not just talking about millionaires and billionaires—many middle income investors and retirees rely on dividend and investment income as all or a part of their income. There were 25.4 million tax returns filed in 2009 that showed dividend income, 63% of which were filed by Americans aged 50 or older.  So raising taxes on dividends and capital gains doesn’t just effect the businesses looking to hire, it effects the millions of retirees who have planned their lives around investments and rely on that income to pay their bills and live their lives.  Raising rates could be devastating to their financial positions and ultimately, their ways of life.

As Jim Pethakoukis at the American Enterprise Institute notes, US taxation on capital income is already among the highest in the world.  Increasing taxation on this income could make the United States even less competitive than it already is.  And historically, the rates have been even higher, as they were in the Clinton administration.  It’s no wonder that many corporations, such as Amazon, opt to shelter their overseas earnings by leaving their income overseas.  President Clinton, realizing that taxes on investment income were high enough, saw fit during his presidency to lower the rate before President Bush lowered it even further.  The idea that over-taxation of capital income is high is indeed a bipartisan one.

Raising rates on investments would be detrimental for economic growth at a time when we should be encouraging investment now more than ever.  Taxing investment income harms economic growth, job creation and living standards for millions of retirees in this country.  Leaving rates as-is could help drive growth and give some security to older Americans who rely on this income.

Zack Christenson writes on research topics for the American Consumer Institute

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