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Why hiking taxes on the 'rich' doesn't work

Even Peter Orszag President Obama's former budget chief says tax cuts should be extended.

Even Peter Orszag, President Obama's former budget chief, says tax cuts should be extended.

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Updated: May 3, 2013 12:14PM

Driving with one foot on the accelerator and the other on the brake is likely to get you nowhere, but certainly will burn out vital parts of your car. Similarly, cutting taxes on the middle class, but increasing them on the "rich" is likely to result in an economic burnout.

Even President Obama's recently departed budget chief, Peter Orszag, made news in a New York Times op-ed last week, seeming to suggest that tax cuts for those making over $250,000 a year should be extended for at least two years. The president has insisted that the 2001 and 2003 tax cuts for those making over that amount should expire on schedule at the end of the year.

The issue of tax cuts is a truly divisive one in American politics and American society. There are plenty of logical arguments against a massive tax increase -- which is what would happen if the current tax rates expire. After all, we're in the midst of a grueling recession, and it doesn't make sense to raise taxes on anybody in a recession, unless you're truly trying to punish success.

Yet there's a certain political appeal to raising an estimated $700 billion over the next 10 years. That's the amount of money that the Treasury says would be collected if the Bush tax cuts expire.

Of course, the argument that raising tax rates on the rich would bring in all that money presumes that those successful enough to earn more than $250,000 a year would continue to work hard so they could pay more in taxes. Some might find creative tax dodges, while others might simply decide to slack off if they must pay more of the next dollar they earn in taxes.

Why poor, middle class should oppose tax increases on 'rich'

It's tough for middle-class people caught in the recession to have any sympathy for the wealthy. In fact, there is no reason at all to feel sorry for those who must pay more taxes. But there is a good reason to fight against any tax increases, even on the "rich."

The real reason to oppose increasing tax rates on the wealthy is that it's a good bet they could do more to help the economy if they keep their money rather than have their earnings confiscated by the government and spent on another round of stimulus.

In fact, late last week Obama made it clear that he wants to raise taxes on the wealthy, taking their money because "there are a lot better ways of spending it."

Now there's the crux of the issue. Who will do a better job of spending the money?

Let's take a look at how the stimulus programs have fared so far, under both Democratic and Republican leadership:

*Two homeowner mortgage modification programs -- the Home Affordable Refinance Program and the Home Affordable Modification Program-- have been dismal failures.

*Shovel-ready jobs programs have left us with a climbing unemployment rate.

*Homebuyer tax credits caused a brief spurt of activity, then an over-the-cliff slowdown to the lowest monthly sales figures on record.

*Cash-for-clunkers boosted newer car sales but left many defaulting on monthly payments they didn't have when driving their old paid-up cars.

Sure, things could have been worse if the government hadn't gotten involved.

But did government do such a good job of creating economic growth that you're willing to fork over anyone's earnings to let them try again?

The "wasteful" rich

It's easy to rationalize that the "rich" can afford to pay those taxes, or that they would have spent that money on frivolous things that no one else can afford. But if a "rich" person buys a new house or a new car, or even a yacht, it means jobs for those employed to build those purchases. If a rich person invests in a business, either directly or through stock purchases, it means business can grow and hire more people.

The most famous example of the fallacy of taxing the rich occurred 20 years ago, when Congress passed a luxury tax on yachts. The rich simply stopped buying boats. But the carpenters and electricians at Brunswick Corp. lost their jobs as the boat business took a dive.

Struggling middle-class people definitely need a tax cut so they can get their finances back in shape and pay off their debt. Consumer debt has been paid down for the past six months in a row, recording a $3.6 billion drop in July. That's good planning for those families and individuals, but it doesn't help the economy grow. Middle-income people definitely need a tax cut, just to survive these tough times.

But only "rich" people by definition have the "extra" money to buy things and invest to create economic growth. Do we really want to tax that "extra" money away -- and give it to the government to spend? Does that make any economic sense outside of politics and our emotional desire to make everyone suffer equally through these tough times?

What we really need to bail us out -- as individuals, businesses, and as a nation -- is economic growth that creates more jobs, more spending and thus more tax revenues based on growth. Our economy can do that if we give it a fighting chance. And that's The Savage Truth.

Terry Savage is a registered investment adviser.

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