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Health Reform Threatened by Conservatives' Anti-Tax Fantasy

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By Steven Pearlstein
Wednesday, July 29, 2009

Nothing has been more damaging to rational discourse about economic policy than the notion, peddled relentlessly by Republican conservatives and accepted by too many centrist Democrats, that raising taxes is always and everywhere bad for the economy.

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Mind you, there's very little evidence supporting this view -- it's an article of faith and a convenient way for politicians to pander to their constituents. Reality is a whole lot more complicated. The economic impact of a given tax increase can be positive or negative, depending on who is taxed, how the tax is structured and how the tax revenue is used.

What we can say for certain is that, in the context of the political debate in Washington, the impact of tax changes is almost always overstated.

The reason I mention all this is because the liberal leadership of the House wants to pay for health-care reform in part by imposing an income tax surcharge on households earning more than $350,000 a year.

Personally, I don't think that's a good idea. We're already spending -- and wasting -- so much more than any other country on health care that we can surely pay for universal coverage within existing health expenditures. What's needed is not more money but the political will to lower the costs of the health-care system while redistributing its benefits.

But if Congress is unable to muster that political will, then the next-best option is to pay for health reform by raising taxes. And given the increasingly unequal distribution of income, it makes both political and economic sense to raise most of that money from upper-income households.

Republicans realize that they can no longer get away with arguing that taxing the rich is bad because it reduces the amount of money that trickles down to everyone else. So their new anti-tax tirade claims that imposing a surtax on top earners' personal income will be disastrous because that is the rate -- not the corporate rate -- at which most small businesses are taxed. And because small businesses create all the new jobs, that's amounts to a tax on job creation.

On closer inspection, however, most of that isn't true.

For starters, small businesses don't create all the new jobs, as I explained in a column earlier this month. Job creation goes on at firms of all sizes, with much of it coming from relatively few companies that start small and get big rather fast. The percentage of Americans employed by small business has increased only modestly over time.

As to that Democratic surtax, it turns out that most of it would not come from small business and most small businesses would not be subject to the surtax.

According to data compiled by the Tax Policy Center at the Urban Institute and Brookings Institution, only 23 percent of taxpayers who would be subject to the surcharge derive most of their income from business profits. The bulk of the proposed surtax would be paid by doctors, lawyers, investment bankers, corporate executives and people with lots of investment income.

Moreover, of the roughly 13 million taxpayers who derive most of their income from business profits, fewer than 500,000 would be subject to any surtax at all -- and of those, fewer than 100,000 subject to the full 5.4 percent surtax. That 5.4 percent rate, by the way, kicks in only after a taxpayer's income (salary and profits) rises above $1 million, which would typically be a business with more than $10 million in revenue and more than 100 employees. That's hardly the small, cash-strapped start-up that animates the Republican anti-tax fantasy.

In the Republican myth, small-business owners take every dime they earn in profit and plow it back into the business by investing in new plant and equipment and hiring new workers. Any increase in an entrepreneur's after-tax income merely reduces investment and job creation -- or so the story goes.

In the real world, however, it doesn't quite work that way. The reason an entrepreneur buys machinery or hires new workers is not because he has an uncontrollable urge to create jobs and grow the economy -- it's because he expects to generate enough additional sales to cover those additional expenditures and generate a reasonable profit as a result. For small businesses, those expenditures are paid with pre-tax money, not after-tax profits. The only reason an entrepreneur might not want to reinvest his pre-tax profits back into the business is that he knows of an investment that offers a better pre-tax return or he wants or needs the money to spend for himself.

It's worth noting that the biggest winners from health-care reform are likely to be the 50 percent of small businesses that still provide health insurance to their workers and pay, on average, about 20 percent more for their policies than do big businesses. Democrats are also proposing to give tax credits to small businesses with low-wage workers that provide insurance. For many small firms, the benefits of those tax credits and lower premiums will more than make up for the real or imagined burden of higher marginal tax rates.

Final point: The money generated by a health surtax isn't going to disappear into a mattress -- it will be used to provide health care to tens of millions of Americans who now have no insurance, or too little. That will require more nurses, more doctors, more lab technicians and, yes, more government bureaucrats -- more than enough jobs to offset those lost as a result of a surtax on wealthy Americans.

Steven Pearlstein will host a discussion today at 11 a.m. at http://washingtonpost.com. He can be reached at pearlsteins@washpost.com.


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