POLITICS

Ernst & Young: Obama tax hike will shrink economy, cost 700,000 jobs

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Politics,Beltway Confidential,Conn Carroll

A slew of tax hikes supported by President Obama will shrink the U.S. economy by 1.3 percent and cause 710,000 job losses, according to a new Ernst & Young report prepared on behalf of the Independent Community Bankers of America, the National Federation of Independent Business, the S Corporation Association, and the United States Chamber of Commerce.

Authors Robert Carroll and Gerald Prante write:

The concern over the top individual tax rates has been a focus, in part, because of the prominent role played by flow-through businesses – S corporations, partnerships, limited liability companies, and sole proprietorships – in the US economy and the large fraction of flow-through income that is subject to the top two individual income tax rates. These businesses employ 54% of the private sector work force and pay 44% of federal business income taxes.1 The number of workers employed by large flow-through businesses is also significant: more than 20 million workers are employed by flow-through businesses with more than 100 employees. … This report examines four sets of provisions that will increase the top tax rates:

  • The increase in the top two tax rates from 33% to 36% and 35% to 39.6%.
  • The reinstatement of the limitation on itemized deductions for high-income taxpayers.
  • The taxation of dividends as ordinary income and at a top income tax rate of 39.6% and increase in the top tax rate applied to capital gains to 20%.
  • The increase in the 2.9% Medicare tax to 3.8% for high-income taxpayers and the application of the new 3.8 percent tax on investment income including flow-through business income, interest, dividends and capital gains.

With the combination of these tax changes at the beginning of 2013 the top tax rate on ordinary income will rise from 35% in 2012 to 40.9%, the top tax rate on dividends will rise from 15% to 44.7% and the top tax rate on capital gains will rise from 15% to 24.7%.
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This report finds that these higher marginal tax rates result in a smaller economy, fewer jobs, less investment, and lower wages. Specifically, this report finds that the higher tax rates will have significant adverse economic effects in the long-run: lowering output, employment, investment, the capital stock, and real after-tax wages when the resulting revenue is used to finance additional government spending.

Through lower after-tax rewards to work, the higher tax rates on wages reduce work effort and labor force participation. The higher tax rates on capital gains and dividend increase the cost of equity capital, which discourages savings and reduces investment. Capital investment falls, which reduces labor productivity and means lower output and living standards in the long-run.

  • Output in the long-run would fall by 1.3%, or $200 billion, in today‟s economy.
  • Employment in the long-run would fall by 0.5% or, roughly 710,000 fewer jobs, in today’s economy.
  • Capital stock and investment in the long-run would fall by 1.4% and 2.4%, respectively.
  • Real after-tax wages would fall by 1.8%, reflecting a decline in workers‟ living standards relative to what would have occurred otherwise.
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