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Peter Crabb: Higher taxes on wealthy, corporations will distort economy

The taxman cometh. It’s just not clear everyone knows for whom.

In his State of The Union address, President Obama laid out a “blueprint” for the “built to last” U.S. economy. To pay for this new economic architecture the president proposes higher taxes on “the rich,” who need to pay “their fair share.”

Tax policy is also a hot topic in Idaho. The :egislature is considering a number of proposals that may lower tax rates for some, like businesses that move into the area, and raise taxes for others, like those industries that now have sales-tax exemptions.

When studying these proposals, policymakers should consider who actually pays. There are basic economic principles that shed a lot of light on the question.

The federal government raises revenue using various taxes, the most important of which are income taxes and payroll taxes for social insurance. State and local taxes, on the other hand, most often take the form of sales and property taxes.

Economic principles show we can best judge the efficiency of any tax by looking at the costs it imposes on taxpayers. Two key economic principles are at play here: (1) People respond to incentives, and (2) The true cost of any action is what you give up to get it.

The first principle shows that society loses when taxes alter incentives and distort the allocation of resources. Well-designed tax policies minimize the amount of economic distortion that occurs when businesses and individuals pay for their work and labor.

A good example is found with income taxes, both corporate and individual. Because interest income is taxed, the current state and federal tax laws discourage saving and encourage borrowing.

This disincentive disappears with any consumption tax, like sales taxes. For this reason some have argued that the U.S. should switch to value-added taxes like those used more frequently in Europe.

The second economic principle shows us that the administrative burden of complying with the tax laws is a true cost of any tax policy. Well-designed tax policies will also minimize the amount of money spent complying with tax laws.

The U.S. Tax Code is one of the most complex and burdensome systems in the world. Many resources are therefore taken out of other productive uses and paid to accountants and tax lawyers. By some estimates this amounts to $200 billion in foregone opportunities each year.

Tax reform is needed. But how much, and for whom? What is your “fair share”?

Economic principles shed light here again: The burden of a tax is not always borne by who pays the tax bill.The income-tax burden in this country is already highly progressive. The top 60 percent of all Americans pay at least 95 percent of all income taxes, federal, state, and local. But again, income taxes discourage savings. So these wealthy Americans are more likely to spend than to invest, lowering the number of workers companies hired. The U.S. corporate tax rate is the highest among developed countries, but corporations don’t really pay taxes. The burden of the corporate taxes falls on the owners, the workers and the customers.

When corporate taxes are raised, the cost of producing goods and services also rises. Corporations then have an incentive to cut back production and lower employment or wages. The supply of the goods and services also falls, raising the price to consumers.

Basic economics shows that people respond to incentives and that opportunity costs matter. If the new “blueprint” for the U.S. or Idaho economy means more taxes on the rich and corporations, we will see more distorted incentives and wasted resources.

Death and taxes are a certainty. No matter who gets the bill, we all pay.

Peter Crabb is a professor of finance and economics at Northwest Nazarene University in Nampa. Reach him at prcrabb@nnu.edu.

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