Top income tax rates likely to rise in 2010, probably not for the last time

Income tax increases are in the air. Unless something unforeseen surfaces on the economic or political landscape, it looks like the Obama Administration and the Democratic Party-led Congress will move forward with a plan to increase the two top federal income tax brackets to 39.6 percent and 36 percent for tax year 2010, as part of the administration's plan to cut the budget deficit.

Look for all House and most Senate Republicans to vote against the measure, except the handful of GOP Senators up for re-election in 2010 who face strong competition from a Democratic challenger.

Still, with the aforementioned increases likely, one unresolved question remains: Should Democrats push to increase the top two rates even more, and or add another top bracket, for, say, incomes over $300,000?

Top rate headed to 45 percent?

I go back and forth on this question, some days favoring a higher top rate, some days not, and that usually means it's a good issue for my colleague and friend David H. Wang, a macroeconomic modeler.

"Well, on the one hand, if you raise the top income tax rate to 45 percent for incomes over $300,000, you will net an additional $200-250 billion per year in federal tax receipts, increasing by about $20-30 billion per year after that, which will shorten the time it takes to balance the budget," Wang said.

"On the other hand, there will be some capital flight to tax havens and other higher-investment return zones," Wang said. "Also, by increasing taxes a second time, you run the risk of taking some demand at the high-income end out of the economy, although the negative impact on GDP varies, depending on the model's assumptions. It would certainly be safer to raise the top rate again after the recovery is in its second year."

Will top tier miss the dough?

The presidential scholar (and my Ph. D. committee chair and presidential studies mentor) W. Wayne Shannon, Professor Emeritus at the University of Connecticut at Storrs, makes this argument, which has been supported by my own observations of family members and friends over the years: "You can tax upper-income citizens and the rich. The extra 10 or 20 percentage points they pay -- they won't miss it or need it, and it will do so much social good."

Shannon was correct then and he's correct now. Oh, sure, there will always be protests from those earning $500,000 a year saying, 'You bet I'll miss it!' Maybe so. But the stronger argument forwards that, "If you're throwing down five hundred or four hundred thou a year, be grateful that you are in that august club. You're quite fortunate." And if the higher tax means you get a new BMW every four years instead of every three, isn't that a modest sacrifice when compared to the good that tax money will do for society?

Still, and it may sound like a fine point, even if upper-income citizens don't miss the extra money, doesn't necessarily mean it's the macroeconomically-optimal policy. Based on Wang's economic models, it's probably best to wait to raise rates a second time until at least 20011.

Then, after sustainable economic growth is in place, yes, we will need to increase the top rates again or impose a 45 percent bracket or maybe both, even with significant entitlement reform. The nation must pay for debt racked up over the past decade and get the federal budget back in surplus -- the way it was in 2000.

Some may counter that a second tax increase won't be necessary, but the deficits say otherwise, and right now it doesn't look like there are too many other viable alternatives.

Financial Editor Joseph Lazzaro is writing a book on the U.S. presidency and the U.S. economy.

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