Congress Passes Fiscal Cliff Deal

We now see who are “millionaires and billionaires” in practice. They are individuals with income over $400,000 or married couples with income over $450,000. Their top tax bracket rises from 35% to 39.6%, an increase of 13%.

The capital gains tax rate goes from 15% to 20%, an increase of 33%.

The temporarily reduced payroll tax rate of 4.2% reverts back to 6.2%, an increase of 48% on all wages up to around $110,000.

The spending problem was not addressed.

There was one positive. The threshold to be forced into the “Alternative Minimum Tax” was set in 1993 and never adjusted for inflation. Incomes and prices have risen since then, so today much of the middle class would be ensnared in this regime that disallows most deductions including state income tax. Every year, Congress provided a temporary fix, and now they have finally made it permanent.

An increase in the tax on high incomes may not have a large immediate effect. Most high earners do not consume all of their income. They spend what they need to maintain their lifestyle and invest the remainder, though some may cut their consumption budget to keep a fixed ratio of their income. The damage done by this tax hike will be felt in future years, as it makes capital harder to accumulate. Our economy (and job creation) depends on capital accumulation. This tax hike in effect transfers capital out of the hands of those who may save it prudently into the hands of the government to be consumed.

Raising the capital gains tax rate strikes a blow directly at the entrepreneur and the investor. Fewer new businesses make sense to start or finance. Investments in new businesses are risky, and most are total losses to the investor. The few winners must earn enough to pay for all the losers. A higher tax on gains raises the bar that an investment must get over. There may be a long delay so that most will not see the connection. In addition, it is difficult to imagine the products that are not in the market but which would have been under a friendlier regime. One thing is clear, mature businesses are managed to reduce cost, which often means layoffs. Job creation is in new businesses. Higher taxes on capital gains may only hurt a few people directly. The indirect impact will be felt by everyone in the job market, along with every retail store, restaurant, and manufacturer of consumer goods.