Conservative Principles Now

The House and Senate are working to reconcile their differing health care reform bills into one final bill. Tax increases remain a stubborn sticking point. The House prefers a surtax on high-earners and the Senate an excise tax on so-called “Cadillac” health insurance plans that cost over $8,500 for individuals and $23,000 for families.

Labor unions, and their backers in the House, have made clear they are staunchly against the excise tax. Congressional negotiators are now looking to reduce it so it has less of an impact on union members, but will need to raise other taxes to replace the lost revenue if they do.

Their latest idea to bridge the divide is to apply the payroll tax to investment income for the first time. Currently, the payroll tax applies only to wages. Increasing taxes on investment income would be a bad idea at any time, but doing so now as the economy is just emerging from a deep recession is downright irresponsible. We are in the beginning of recovery and higher taxes on investment would threaten that recovery. The Obama Administration has reportedly even considered that it will likely have to put off the tax increases it wants - including increasing taxes on capital gains and dividends – because of the weakened state of the economy. If Congress goes through with its plan to hike taxes on investment income and capital gains it will hurt economic growth at the worst possible time and contradict the sensible concession of the administration that taxes should not be raised now.

The tax code already taxes investment too much. High taxes on capital gains, dividends, interest and business income increases the cost of capital. This drives down wages and costs the economy jobs. Increasing these taxes will further depress investment at the very time when the economy needs new investment to grow and create jobs.

Seniors lose

Applying the payroll tax to capital gains and dividends would hurt those that rely on investment income for their livelihood – especially seniors. Seniors live off their dividend and interest income in addition to their pension and Social Security checks to pay for their living expenses, including basics such as housing, food and medical care. When the taxes on them go up, seniors have less after-tax income for expenses. Seniors also sell assets, recognizing capital gains, when their expenses exceed their income, so raising the tax on capital gains further reduces their resources. In addition, raising the taxes on capital income and capital gains will lower asset values, leaving seniors less to sell when they need it.

Nearly 30 percent of all stocks are held in retirement savings plans. Most of the seniors that rely on the income from these plans for their livelihood are not “fat cat” investors that have been the target of so much criticism lately. They are people that spent their working years saving money for their own retirement in mutual funds, 401(k)s, IRAs, and other savings vehicles. Slamming them now with higher taxes would punish them for a lifetime of frugal living and careful planning.

All stock holders, including seniors, already pay a substantially higher real capital gains tax rate than the current rate specified in law because capital gains are not indexed for inflation. Increasing the rate will worsen this effect and further increase the tendency of investors to hold on to assets to avoid paying the capital gains tax. This will result in capital not being efficiently allocated to the most deserving projects, which will further lessen economic growth.

Breaking the link with payroll and benefits

Expanding the payroll tax to investment income would also further dissolve the fundamental policy that taxpayers pay payroll taxes during their working years and receive benefits for paying them during their retirement years. The policy was first weakened when the traditional cap was eliminated so payroll tax was applied to all wages and salaries. The Senate bill took this a step further by increasing the Medicare portion of the payroll tax for taxpayers making more than $200,000 a year to pay for a new, separate health care entitlement program. Applying the payroll tax to investments is the next step down a slippery slope where Congress further obliterates the tie between the payroll tax and the retirement benefits it is supposed to fund.

Congress’ willingness to violate this fundamental policy exemplifies how determined they are to pass a health care bill. At this point, they appear willing to tax anything and violate whatever principles previously defended to get the bill over the finish line. Since the economy is still shedding jobs and it’s clear that anything approaching full employment is a long way off, it is time for Congress to take notice of the economic harm they threaten. A good first step would be to drop this idea of increasing taxes on investment. Doing so is a common sense action that both the left and right can agree on. Will Congress wake up and see what everyone else does?

It is fun and politically profitable to attack banks and bankers, especially in the wake of a bailout program estimated to have cost American taxpayers some $150 billion. Given this, the plan floated yesterday by the Obama Administration to charge a “fee” (read tax) on financial institutions to cover losses under the TARP program is understandable. That doesn’t make it sensible.

The plan will do nothing to force those responsible for much of TARP’s losses — primarily AIG, General Motors, and Chrysler – to reimburse the Treasury one cent. That money is likely lost. It will, however, force firms that didn’t take bailout money – and those that took money but have already paid it back with interest, to subsidize the money losers.

Worse, it promises to do so in a way that is going to make the financial system less sound, and possibly even make it harder for ordinary Americans to save for retirement.

As reported so far, there’s no word on exactly what form the fee would take, but several potential methods have been mentioned, each worse than the next one.

• Surtax: It could be a surtax on top of existing business taxes, to be paid by firms over a certain size. But this would hit the healthiest firms – those least likely to impose bailout costs. Of course, the mere existence of such a surtax will immediately reduce the stock price of financials that still need to raise capital levels, and are vulnerable to further losses on commercial real estate, consumer products, etc.

• Excise tax: Under an excise tax, assessed on assets, payroll, or perhaps average pay of top executives, firms would be taxed more “equally”. But that means problem institutions will be further weakened and be even more vulnerable to failing. Moreover, excise taxes no doubt will be used to penalize politically unpopular expenses – regardless of justification — increasing government micromanagement.

• Surcharge on financial transactions: A third proposal would be to charge a 0.25 percent tax on all stock, bond or other financial transactions. Unfortunately, this idea would mainly hit the 401(k) type retirement savings accounts of ordinary Americans, for a very high proportion of stock transactions are connected with the management of these accounts. The tax, small as it seems, will be added to the costs paid by these plans, thus further reducing the money that future retirees will have to live on.

This is completely the wrong approach to reducing the swollen deficit, and will inevitably cause more problems than it solves. It is a bad idea being used to score political points, and should be dropped.