Under Obama's new tax plan, everyone pays more

In tonight’s State of the Union Address, President Barack Obama is expected to call for tax increases to pay for benefits for the poor and middle class, as well as other new spending. Chris Edwards is the director of tax-policy studies at the Cato Institute. I talked with him about what Americans can expect from the president’s tax proposal.

The president wants to raise the capital gains tax rate to 28 percent, returning to the rate it was before President Bill Clinton reduced it to 20 percent in 1997. What is a capital gains tax, and why did Clinton choose to reduce that rate? Capital gains represent income that has already been taxed. Not only the United States, but every industrial country around the world, has a special, lower rate for capital gains because the income’s already been taxed and because of the important role of capital gains in the economy.

How has it already been taxed? If you own shares of corporate stock and the corporation is expected to earn higher profits, the stock price goes up. The corporation is itself taxed on those extra profits, but then you’re taxed again as an individual holding the individual share. So it’s double taxation.

So Clinton’s rationale, and later President George W. Bush’s as well, was that a lower capital gains tax rate encourages investment in the economy. That’s right. Capital gains is the amount of income when you sell an asset like a business or a share of corporate stock. You’re taxed on the amount of money you earn above and beyond how much you paid for it. Capital gains play a really important role, for instance, in the high-tech economy and for start-up businesses. A lot of the people who invest in start-up businesses, like in Silicon Valley, are expecting a big capital gain later on when they do an IPO [or] when they sell the business. So keeping capital gains tax rates [low] is very important so investors invest especially in these young and growth companies. Clinton and other presidents have favored lower capital gains tax rates because they’re good for economic growth. Bush lowered the rate to 15 percent. So under President Obama, if this proposal goes through, the rate will almost be twice as high as when he first came into office, far higher than the rate in other countries. The average rate among our trading partners is just 16 percent.

The president also wants to expand poor and middle-class family tax credits. What can you tell us about that proposal? President Obama wants to increase the earned-income tax credit. He wants to increase the childcare credit. He wants to create a new $500 credit for second earners in families. In other words, if the husband is already working and the wife goes back to work, Obama is going to incentivize that by giving it a special tax credit. I think this is the wrong direction for the tax code. Tax reform is the idea that you want to get rid of these credits and lower overall rates, and that is the direction we should be going.

Obama is also expected to talk about capping the amount of money people can contribute to retirement plans. Tell us about that. President Obama proposes to cap the amount of money that you can accumulate in your 401(k) plan because he thinks that, for high-income people, there should be a maximum amount that they should be able to accumulate. The problem with that is it is an anti-saving change to the tax code. When you think about it, it’s better for everybody if wealthy people save more because their saving goes into the economy and helps business expand, … but President Obama’s proposal goes in the opposite direction, and he will be penalizing higher-income people for saving.

Some would say it’s better to tax all that money so the government can spend it on programs the president says will help Americans as opposed to people just hoarding that money. What do you say to that? I think, most fundamentally, that the federal government already raises enough money. Federal taxes are at high levels. Frankly, the problem in Washington is an excess of spending. We still have a half-a-trillion dollar deficit, not because revenues are too low, but because spending is higher than ever.

The president wants to impose new fees on the nation’s largest banks. What do you make of that? The fundamental thing to remember about taxes on banks and other corporations is, ultimately, we pay those taxes as consumers. Banks, of course, will pass on any additional taxes to consumers, in other words, giving you a lower interest rate for your savings account. Or they will impose higher fees on you. So the Obama administration may claim that they’re getting this money from a bank tax, but, ultimately, it’s an additional tax on actual Americans.

Listen to Kent Covington and Chris Edwards discuss the president’s tax proposal on The World and Everything in It.