As our economy meanders down the road to recovery, yet to hit its stride, the American dream slides out of reach for too many. Nearly one in 10 Americans can’t find work. If you consider those who have given up looking or settled for part-time work, that number jumps to nearly one in five.
Things are bad – and they are about to get worse. On Jan. 1, Americans will face the biggest tax increase in history. Marginal income tax rates will increase for every taxpayer. The capital gains rate will climb 33 percent. Dividend rates will jump by as much as 164 percent. The child tax credit will fall 50 percent, so your kids will cost more. Compound that with the return of the marriage penalty, and it is enough to make anyone wake up screaming.
Unless Congress acts to extend existing tax rates, American workers and business owners will fork over an additional $2.6 trillion in higher taxes over the next decade, as estimated by the Congressional Budget Office, despite the fact that President Obama’s former economic adviser, Christina Romer, tells us that “tax increases are highly contractionary.”
First, let’s take a look at the impact of the scheduled jump in marginal tax rates. Small businesses, our job creators and the backbone of our economy, will be among the hardest hit by these tax increases because many of them pay taxes through the individual tax system. The top marginal income tax rate will grow to 39.6 percent from 35 percent in 2011. Compound that with the loss of certain itemized deductions and personal exemptions, and these small businesses face rates as high as 41.6 percent. Approximately half of the business income reported on tax returns in 2011 will be subject to the top two marginal rates.
Investors who earn capital gains and dividend income will also feel the pain. Capital gains rates are scheduled to jump from 15 percent to 20 percent, an increase of 33 percent, in 2011. Then, in 2013, thanks to the recently enacted health care legislation, they will again increase, rising to 23.8 percent. In other words, in 2013, capital gains rates will have increased 59 percent from current rates.
Taxes on dividend income will skyrocket, rising from 15 percent to as high as 39.6 percent, an increase of as much as 164 percent. And because health care reform legislation is the gift that keeps on giving, dividends, like capital gains, get slammed with another increase in 2013. Without congressional action, dividend rates could be as high as 43.4 percent in 2013, which would be an increase of 189 percent over 2010 levels.
Higher taxes on capital gains and dividend income rates have numerous consequences. First, an increase in the capital gains tax rate could adversely affect investment decisions by creating a “lock-in effect,” in which investors avoid these higher taxes by not selling their assets. The lock-in effect can reduce economic growth by preventing the reallocation of capital to more efficient investments.
Second, for companies that employ Americans and keep our economy moving, raising dividend rates could discourage investment and incentivize companies to use excessive debt financing, causing greater economic instability. All taxpayers who receive dividends, regardless of income level, could be hurt by potentially lower dividend payouts.
Finally, the proposed increases could result in inefficient allocations of capital and allow the tax code to unduly influence a company’s investment decisions. That’s because, beginning in 2011, dividends and capital gains will no longer be taxed at the same rate. Synchronizing dividend and capital gains rates encourages the most efficient allocation of capital and increases fairness because the tax code does not influence a company’s decision to retain earnings versus distribute them.
Congress should wake us from this nightmare and stop these tax increases. That would give small businesses, the nation’s job creators, confidence, certainty and assurance that they will get a return on their investment and sweat equity. It would allow workers to keep more of the pay they earn. It would let our seniors worry about their grandchildren and not their tax bills. It would let Americans sleep peacefully, knowing that tax increases won’t dampen their entrepreneurial spirits or deter investment in our country’s future. If Congress were to act now, it would bring certainty to everyone paying taxes and create renewed hope for the American dream.
Caroline Harris is executive director and chief tax counsel for the U.S. Chamber of Commerce.