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Why Not Soak The Rich? I Want My MTV!

April 1, 2009

The Economist’s Free Exchange economics blog posted an excellent warning for those who flippantly dismiss critics of tax increases under President Obama’s new budget. Obviously very few of us feel sorry if banking executives take away a little bit less of those million dollar bonuses people are so up in arms about, but it would be wise to remember the increase in the marginal tax rate applies to many in the upper middle class (for families, $250,000 a year in gross adjusted income).

The upper middle class is quite well off and definitely more able to shoulder an additional burden than, say, an unemployed senior citizen, no?  Sure, if you have more, then you should do your part to keep society running smoothly, especially during a recession. The Economist points out, however, that increasing the tax rate doesn’t only have effects on luxury consumption, but creates a significant disincentive to save or start a small business.

Of course, you may say, “who is starting a small business in this economy?” In fact, many of today’s most important corporations began humbly in the Great Depression and the severe recessions during the Eisenhower, Nixon, and Carter administrations. Soak the rich? Studies show that the 1993 Omnibus Budget Reconciliation Bill, which increased taxes slightly on the upper middle class, decreased entrepreneurship (measured by rates of the newly self-employed) by as much as 20%.

This means that, especially during a time in which the banks, huge law firms, and giant corporations such as IBM and Google are laying off employees due to their risk aversion, we might be discouraging risk seeking individuals from picking up the slack and starting the next Hewlett-Packard, Yellow Pages, FedEx, or even MTV (Great Depression, Great Depression, 1973, 1980).

Not to mention, as the Economist surmises, the impact on angel investment, which is responsible for approximately as much start-up funding as all the nation’s venture capital firms combined.  We fixate now on the refusal of the nation’s banks to offer loans, but resolving this only helps those small businesses that have already been on the ground and running for years to cover payroll and investment.

Most new businesses, on the other hand, rely on private savings, seed financing from friends and family, and then angel investors until the road to profitability becomes clearer.  A higher marginal tax rate on the upper middle class means your buddy that wants to start a solar energy company in his garage may not be able to turn to his doctor uncle for a few thousand bucks to help out with his start-up costs.

Ironically, this comes at a time when the dream of many on the left, breaking up the political influence of America’s multinational corporations, is within reach. Peter Bregman argues on that “small is the new big” when it comes to this economic downturn as clients increasingly desire a relationship based on trust and stability, turning away from impersonal large firms plagued by layoffs which breed uncertainty among their employees.

What better way to chip away at the lobbying power of the nation’s largest firms than for smaller firms to steal their core, most profitable business away in a period of uncertainty?  Or better yet, new companies built on stakeholder principles to takedown the dinosaurs that feast on public subsidies?

Does this mean that taxes shouldn’t be increased? Not necessarily. We could provide other incentives for people to open small businesses, and it’s possible that new re-distributive policies will encourage risky behavior by providing a more secure safety net in case a budding entrepreneur’s venture fails.

But given Congress’ inability to reach compromise and many “Blue Dog” Democrats’ public waffling on health care reform in the near-term, it seems far more likely that taxes will mostly be spent on failing industry welfare while nipping budding entrepreneurs in the green energy, transportation, and technology sectors.

Yes, I realize this sounds like supply-side economics.  Keep in mind that my problem is not with soaking the ultra-rich, who saw tax rates of over 70% during the Great Depression and thus will fare much better during this downturn, but the impact on the upper middle professional class.  Maybe another solution would be to make new brackets for the ultra-wealthy?

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