One of the many reasons why conservatives start to worry when President Obama talks about income inequality -- as he's likely to do in Tuesday night's State of the Union address -- is what Tracy Wilson is going through right now.
Wilson, 54, owns DeWils, a Vancouver, Wash.-based cabinet making company that's been in his family for more than half a century. His father, now in his 80s, still runs a retail kitchen appliance store, and his daughter is starting her own leather products business. That's just the kind of people they are, though it hasn't been easy in recent years -- the recession cut Wilson's $40 million in yearly revenue to $20 million, forcing him to lay off half of his 200-person staff and to consolidate two factories into one.
Lately, sales have been creeping back up, and Wilson has been starting to hire more people -- skilled workers who make from $18 to $25 an hour. But now he's got to deal with another big new expense: an income tax hike of 4.5 percent, to 39.5 percent, for a new tax bracket filled with super-high-income earners. Wilson’s business is structured such that his profits are taxed at an individual rate, not a corporate one. That profit comes to around $2 million a year, and he says he plows some 80 percent of that back into the business. This year, he was going to spend it on new stuff: the sophisticated saws, sanders and lathes that help him compete in an increasingly mechanized world.
"There's things that we had on the board, a list of equipment that we knew we had to replace, and we've had to scale it back," Wilson says. "There's a $40,000 laser that would increase our capabilities and market share. The increase in taxes are going to exceed that." And it’s not just investment. "I try to get a little more miles on my car, so I'm driving an old Ford truck," Wilson says. "I haven't taken a vacation since 2008. In the past, where I might've bought a piece of art from an art gallery, I now won't. These things just kind of ripple through."
This is the great fear about soak-the-rich policies to combat inequality -- that they will end up hurting the people the economy needs to create jobs and drive growth.
But so far, there’s no solid evidence that Wilson’s experience is broadly shared.
Over time, other initiatives -- such as health care reform -- may start to fix inequality. But right now, asking people in Wilson’s tax bracket to pay more may be the most consequential step Obama has taken to close the income gap. And it is a step, economic data suggest, that the economy will absorb without so much as a hiccup.
Here's an important question to ask about that new top tax bracket: Who's in it?
Some of them -- 13.6 percent of the top 1 percent of income earners, according to an analysis of 2004 tax returns -- are executives of privately-held businesses like Wilson. And they do have a problem with the new tax rates. The National Federation of Independent Business, in an annual survey of its members, found that taxes have replaced low sales as the top concern among small business owners. Some business owners take advantage of a provision in the tax code that allows them to "pass through" corporate earnings as personal income, placing them in the upper economic echelon -- even though they reinvest a lot more of that income than people who simply earn a salary or collect capital gains. That’s why income tax hikes hit them hardest.
But that’s by no means the norm. Tom Hungerford, an economist with the left-leaning Economic Policy Institute who used to analyze tax policy for the nonpartisan Congressional Research Service, says the vast majority of small business owners don't make enough to clear the bar.
"So you're just talking about the very top of the income distribution, probably owners of S-corps and some partnerships," he says. "A lot of those are law firms, and I don't think they have huge capital investments." The rest in that bracket are mostly salaried executives, managers, financiers, lawyers and doctors -- who tend to spend their personal income on themselves, not their business.
But here’s another important question: Even if they’re not hiring fewer people because of higher tax rates, are those top earners slacking off, saving less, or spending less than they would otherwise? That’s what the business lobby warns will happen.
Well, we don’t yet know how folks who now fall into those top two tax brackets are reacting to the change. Data about their spending and investment strategies over the past year have yet to be collected and analyzed -- and most haven't started actively planning yet, anyway, since filing extensions is common. Historical evidence, however, is pretty conclusive. “Changing tax rates is likely to have small effects on supply of labor and capital and on output,” the Congressional Research Service reported earlier this month.
Wealth managers dealing with high net worth individuals say that’s because, by and large, people making enough money to land in those top two tax brackets are affluent enough that taxes don’t materially affect their quality of life. And, according to consumer confidence data from the New York Fed, they expect to do even better over the next year.
"My mega-wealthy clients are surprisingly sanguine about their responsibility to pay more taxes," says Mark Avallone, president of Shady Grove, Md.-based Potomac Wealth Advisors. "They may not like it, but almost all of them have said: 'I'm ok with this. I've done well, I can afford a few dollars more.'"
What’s more, the people who do make choices about investment and hiring aren’t likely to be less productive just because more of the marginal return goes to Uncle Sam.
"People who are the job creators are often people who are doing this not necessarily for monetary reasons," says Beth Larson, of Arlington-based Evermay Wealth Management. "They're doing it because they usually love what they do. They are interested in building a business that will survive their own lives."
And here’s a really important thing to keep in mind: Recent years have given rich people an even bigger reason to relax about how much they’re taxed. The Fed’s policy of pumping money into the economy juiced the stock market by more than 30 percent in 2013, which fattened the investment portfolios of the top one percent by much more than the higher income taxes took out, making even this year's increase in capital gains taxes easier to swallow. That’s why their share of income has ballooned in recent years, with their average tax rates at historic lows:
Now, rich people have lots of ways to protect their income. In response to the new top rates, tax planners expect to see an uptick in profit-shifting maneuvers, such as putting more money into real estate and taking out cash-value life insurance policies. And all the chaos and unpredictability in Washington, along with new super-high taxes in countries such as France and the U.K., have made the hyper-rich fearful enough to adopt a strategy that corporations learned long ago: socking away money in offshore bank accounts.
"I think that there's a paranoia, a little bit, about what could take place," says Chris Detmer, senior vice president of RBC Wealth Management in the Washington area, "because they are sitting on a nice pile and they're worried it's going to be taken. A lot of people believe we're heading in that direction, so they want to plan accordingly."
The thing is, though, that the United States is still a relatively easy place to keep what you’ve earned: It doesn’t even factor into the top 50 nations for taking money out of the pockets of people earning more than $100,000. To the extent that rich people grumble over higher tax rates, it’s because they’ve been treated so well for so long -- and have realized tremendous gains as a result.
"It's annoying, it's frustrating, but our tax rates are lower than they are in other places," says Lisa Kirchenbauer, president of Omega Wealth Management. "We're just used to them being even lower. There's a lot of business owners who are going to complain about taxes, but you know what? They work around them."
The degree to which even an army of tax planners can protect a rich person’s pot of gold is limited, and economic forecasts usually take their avoidance tactics into account, anyway. The combination of taxes passed at the beginning of last year -- several of which were simply returning to their former rates -- are expected to earn $620 billion for the U.S. Treasury over the next 10 years. That's $620 billion that top income earners won't have, which by the strictest definition is the most effective way to reduce inequality that the president's got.