The Truth About Tax Cuts

Published: Wednesday, 27 Apr 2011 | 9:56 AM ET

By: Ivory Johnson
Scarborough Capital Management, Inc

The ongoing debate over tax relief has lost all integrity, like a favorite sweater long past its prime. Some believe that tax cuts increase the budget deficit while others suggest wealthy citizens have no moral obligation to share their bounty. Worthy positions indeed, but they are two mutually independent arguments, both valid, one having nothing to do with the other.

The recent attempt at supply side economics comes in the wake of an inauthentic evaluation of the Bush tax cuts and the consecration of vague ideals by the most committed. The Congressional Budget Office describes tax reduction as the least effective way to spur the economy and reduce unemployment, as they would only increase the GDP by 10 to 40 cents for each dollar spent. Moreover, tax breaks are financed with borrowed money, as 25 percent of the budget deficit is the direct result of the 2001 and 2003 tax cuts. The government may ultimately pay higher interest rates for the additional debt load, crowding out private investment and increasing the cost of free market activities.

The narrative that tax cuts on the wealthy help small businesses create jobs gives folklore a bad name. After all, only two percent of all small businesses are in the top income bracket. There’s also reason to believe that wealthy Americans spend less of their disposable income than the middle class on consumer goods and services that represent 70 percent of GDP. In fact, the savings rate for the wealthiest Americans decreased after President Clinton’s tax hike, only to surge in the years following the 2001 and 2003 legislation.

Wealthy citizens already shoulder much of the burden, with the top one percent paying 38 percent of all income taxes, much of it squandered, but the grasp of Uncle Sam is relentless.

The social security tax doesn’t apply to earned income above $106,800, yet somehow FICA taxes represent 40 percent of government revenue.  Federal and/or local governments impose five separate taxes: one for income, sales, capital gains, property ownership and large estates.

There are also excise taxes and a host of other hidden expenses that can be adjusted without serious political opposition, ranging from real estate transfer fees to car rental surcharges. Congress could reduce ordinary income taxes to zero, and lo and behold, another tax would take its place.

It’s been reported that many U.S. corporations manage to avoid federal income taxes altogether, so it appears counterproductive to cut the corporate tax rate and allow money to be repatriated from overseas with limited taxable consequences. Keep in mind that Congress allowed corporations to repatriate international profits at the rate of 5.25 percent in 2005, as opposed to the 35 percent corporate tax rate. In lieu of creating jobs, multinational corporations simply rearranged their finances to comply with the law, pursued share buybacks and increased executive compensation accordingly.  The robust volume of available deductions mitigates the tax burden of corporations, creating an environment in which corporate tax payments as a percent of GDP are lower than at any time since World War II.

Having said that, the wealthiest amongst us have generally taken risks that others were unwilling to accept, using their homes as collateral, pursuing advanced degrees in hopes of a promotion and foregoing immediate gratification. It’s easy to forget that failed attempts at upward mobility attack one’s self-esteem like a virus, that the path to success is perilous, littered with the obituaries of worthy participants who couldn’t catch a break, or get a loan. To suggest that the voyeurs of capitalism are ostensibly responsible for the wellbeing of those who made contrasting decisions would ignore the sacrifices they have already made.

The voting populace has been presented with a false argument, that it would be reasonable to commingle altruistic responsibilities with the unmistakable economic reality that the nation must increase its revenue to remain solvent. Tax cuts for the most fortunate certainly create incentives to engage in successful behavior; it just won’t stimulate a weak economy or pay down the debt in the immediate future.  The truth hurts, and sometimes it gets expensive, but right now the United States needs revenue, not rhetoric.

Ivory Johnson is the director of financial planning at Scarborough Capital Management, Inc. He is a Certified Financial Planner, a Chartered Financial Consultant and a frequent guest on CNBC. Mr. Johnson attended Penn State University, where he received a Bachelor of Science degree in finance.

© 2011