As the markets continued to waiver sideways for the first eight months of this year, one of the major roadblocks that’s keeping the economy from turning around is the uncertainty of future tax rates. Most wealth managers know that the 2001 and 2003 Bush tax cuts are set to expire at the end of 2010. Therefore, unless Congress acts to extend or change the current tax rates, most Americans will see at least some increase next year. The simplistic analysis shows that the current 10%, 15%, 25%, 28%, 33% and 35% tax rates will jump to 15%, 28%, 31%, 36% and 39.6%, if the tax law sunsets. Based on projections from FiveCentNickel.com (which are estimates calculated from the 2010 tax rate brackets plus 3% inflation), here’s a quick breakdown of the possible 2011 tax brackets.
To me, the economics are pretty simple. The more money someone has to spend, the more they’ll spend, and the less money someone has to spend the less they’ll spend—unless it’s the government! If 70% of our gross domestic product is based on consumption, then how in the world would anyone think that increasing taxes is going to prompt taxpayers to continue consuming—or even consume more? In my opinion, it’s ludicrous for the government to increase taxes on anyone and then expect our economy to get stronger!
So I decided to look at the historic charted data from the National Taxpayers Union to find out who is really paying the total tax bill. Not to my surprise, according to their statistics, reality was definitely different from what we hear from Washington every day. The data shows that the top 25% of American income earners (those with an adjusted gross income threshold of just $66,000/year) have consistently paid 82% to 86% of all personal federal income tax collected between the years of 1999 to 2007. The table below illustrates the breakdown for 2007:
Imagine—86% of all personal income tax revenue our federal government receives comes from just one-fourth of American taxpayers! So then, if consumption is typically 70% of our gross domestic product, what group is doing that spending? Is it mostly the same top 25% of American income earners? If they have less money to spend, will they’ll actually be willing to spend more—to do their part to help the economy? I’m not a gambling man, but I would bet otherwise.
So the question becomes: How much more will the top 25% of earners be forced to pay in taxes in 2011 if current tax rates sunset? Using the projections from FiveCentNickel.com (which are estimates calculated from the 2010 tax rate brackets plus 3% inflation), here’s a quick breakdown of the possible tax implications for married couples at various incomes above the $66,000/year threshold mentioned above:
Would it be logical to expect that an 8% to 12% across-the-board tax increase for the top 25% of American income earners is going to cause our economy to drop into another recession? Probably not—and by no means do I want my view to be construed that way. However, it does shine a little light on the fact that higher taxes will possibly reduce economic activity to a slower pace than if taxes were reduced.
Now let’s take that logic a little further. That top 25% likely includes the largest percentage of all the small business owners in America. So let’s look at the data above in that context. If a small business owner is making taxable income of $1 million and currently paying a tax bill of $320,000 in federal taxes, that means he is netting roughly $680,000 (excluding all other forms of taxes). If I were in his shoes and looking to manage my own net income, I would make sure I keep myself at $680,000 as future tax increases arrive.
Using the same example, but with the 2011 tax rates that would take effect if the current rate cuts expire, the owner would only net $642,000. So does our government really think that the business owner is going to consume more with less money, or is he going to find ways of spending less so he can maintain his original net income? The results are not brain surgery; most business owner would lay off employees and cut expenses. Anyone who thinks otherwise negates the main objective of a business, which is to make the most money with the least expense.
Therefore, if taxes are increased, regardless of the level of someone’s income, everyone will still have less to spend than they had in the previous year. As I stated earlier, it’s ludicrous for the government to increase taxes for anyone and then expect our economy to improve! For all of the Americans that comprise the top 25% of U.S. income earners, we will probably continue to pay 86% of all personal income taxes—if not more. My only suggestion is that if we ever want to see our economy recover, we should follow the government’s lead: spend money you don’t have, increase your workforce for the future business to come, and when all else fails, just increase your prices on the top 25% of your customer base because, after all, they can “always afford it.”