Bush, Kerry, are far apart on how raising taxes on the rich pans out

Wall Street Journal
August 5, 2004; Page A2

Campaigning last weekend, President Bush offered this attack on opponent John Kerry: "He said he's only going to raise the tax on the so-called rich," the president said in Canton, Ohio. "But you know how the rich is: They've got accountants. That means you pay. That means your small business pays. It means the farmers and ranchers pay."
That's what he said. (I checked the White House transcript, which gets points for faithfully recording the president's unique grammar.) What did he mean?
"He's only going to raise the tax on the so-called rich."
True. The candidates differ sharply on how heavily to tax Americans with incomes above $200,000 a year. President Bush wants a top marginal tax rate of 35%. The Democratic Mr. Kerry would boost rates to 39.6% and undo Mr. Bush's tax breaks for dividends and capital gains for those folks, too. He'd use the money to expand access to health insurance and to subsidize employer-provided coverage.
"You know how the rich is: They've got accountants. That means you pay."
Is the president courting votes from cynics who say the rich avoid taxes and the rest of us pay? Claire Buchan, a White House spokeswoman, explains: "The president is noting that the so-called wealthy have the resources to hire accountants to find ways to reduce their tax bills...."
Quips Jason Furman, a Kerry economist: "If the most fortunate weren't paying taxes in the first place, why did they need the Bush tax cut?"
Seriously, rich folks do find ways to shrink tax bills and alter their behavior after big changes in U.S. tax laws, such as the 1986 law that cut the top rate to 28% from 50%. "If someone has been contributing money to a deferred-compensation plan and tax rates come down to 28% after decades of being at 50%, it's a good time to take money out," says Massachusetts Institute of Technology economist James Poterba.
Higher tax rates prod the rich to search harder for tax shelters and other tax dodges. The latest academic work suggests that lifting the top tax rate to 39.6% from today's 35% (which works out to a 7% decrease in such taxpayers' take-home pay at the margin) would reduce taxable income in that bracket by about 4%.
Overall, though, the government still is likely to come out ahead, as the gush of tax revenues after the 1993 tax increases suggests. "In the last decade, the top rate was as high as 39.6%, and we know at that rate you can collect quite a bit of revenue," says Joel Slemrod, a University of Michigan economist.
"That means your small business pays. It means the farmers and ranchers pay."
The president, Ms. Buchan explains, means that "the so-called wealthy" can afford to hire accountants but "small businesses, farmers and ranchers who are organized as Subchapter S companies don't have those resources, but would nonetheless be subject to the tax increases."
Yes, Subchapter S companies pay taxes on profits at individual income tax rates. But the bulk of small businesses, farmers and ranchers don't make enough to fall into top brackets. They won't pay more under Mr. Kerry's plan. And I've never understood the case for taxing a farmer, rancher or small-business owner who clears $500,000 differently than a corporate executive, lawyer or ballplayer who earns $500,000.
There is a conservative case that the economy does better with smaller government, but it is hard for Mr. Bush to make. "If you want the efficiency of smaller government, you have to have smaller expenditures and smaller taxes at the same time," says Urban Institute economist Eugene Steuerle, a Reagan tax official. By cutting taxes now, but not cutting spending, Mr. Bush is guaranteeing tax increases in the future, Mr. Steuerle argues.
The prospect of such tax increases, no matter who wins, makes it worth listening to rhetoric about the Alternative Minimum Tax. Created in 1970 to make sure the richest taxpayers don't get so many tax breaks that they avoid taxes altogether, it is encroaching on the upper-middle class. It doesn't sound bad -- a 26% or 28% rate -- but the taxpayers affected don't get the full benefit of the personal exemption, deduction for state and local income taxes or miscellaneous deductions. Without changes, the AMT will be bigger than the regular income tax before the end of the decade.
Some savvy tax lobbyists speculate that the need to "fix the AMT" (which both candidates vow to do) could force big changes to the U.S. tax code in the next few years. Some Republicans suggest quietly that the structure of the AMT -- fewer deductions and credits so a broader base of income is taxed, but at a rate lower than would otherwise be the case -- is substantially more appealing than raising tax rates.• Your thoughts? Write to capital@wsj.com3. Online subscribers can see Q&A Tuesday at WSJ.com/CapitalExchange4.
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ABOUT DAVID WESSEL

David Wessel, 50 years old, The Wall Street Journal's deputy Washington bureau chief, writes Capital, a weekly look at the economy and the forces shaping living standards around the world. He also appears frequently on CNBC.

David has been with The Wall Street Journal since 1984, first in the Boston bureau and then the Washington bureau, where he was chief economics correspondent. During 1999 and 2000, he was the newspaper's Berlin bureau chief. He also has worked for the Boston Globe and at the Hartford (Conn.) Courant and Middletown (Conn.) Press. He has shared two Pulitzer prizes, one for a Boston Globe series on race in the workplace in Boston and the other for Wall Street Journal stories on the corporate scandals of 2002.

He is the co-author, with fellow Journal reporter Bob Davis, of "Prosperity: The Coming 20-Year Boom and What It Means to You" (Random House/Times Books, 1998), which argued that the next 20 years will be better for the American middle class than the previous 20 years.

Write to him at capital@wsj.com9.