Judging Obama's Tax Hikes

Nothing drew more criticism when President Obama released his budget last week than his proposed tax hikes on high earners -- defined by his proposals as individuals making over $200,000 and families earning more than $250,000 a year. He would raise the top marginal rates from 33% and 35% to 36% and 39.6% respectively, and limit the value of itemized deductions to 28%. That would mean deductions would be valued at 28 cents per dollar for top earners, instead of 35 cents today. 

Criticism took many forms, but three areas stand out. 

The first is that it's a terrible mistake to raise taxes in a recession. Obama agrees and that's why he postponed the hikes until 2011, which angered more than a few of his Democratic supporters who thought he was breaking his campaign promise. The Obama administration thinks the recession will be over by then. If it's not, the tax hikes can be postponed

The second major criticism from Republicans was that the higher income brackets would cripple small businesses, the crucial engines of economic growth. House GOP whip Eric Cantor went so far as to claim that a majority of those affected by the tax hikes would be small businesses. While many small firms file individual rather than corporate tax forms and would be potentially hurt, how many small business owners make over $250,000? Not many, it turns out. The nonpartisan Center for Budget Priorities says only 1.9% of small business owners would be affected and even that number may be inflated because it includes investors in small businesses who don't have an active role in management. The center also points out that far more small business owners would benefit from the tax cuts that Obama is promising for those making less than $250,000 a year.

The third criticism, which comes from charitable groups, Republicans and some Democrats, is that the limit on deductions will have a devastating effect on private donations. But this is debatable. There's lots of evidence that altruism and religious motives have a far more influential effect on charitable giving than tax benefits. Melissa Berman, president of the Rockefeller Philanthropy Advisors, told Bloomberg News that tax savings are typically low on the list of reasons for making a donation. Others note that the tax benefits of giving are already capped by limits on deductions under the alternative minimum tax. Between 1990 and 2001, when six-figure households were under stricter deduction limits, donations grew at an annual rate of 8.4%, according to the IRS.

One final note. Len Burman at the Brookings Institution's tax blog notes that when a CBO study in 2004 suggested that ending the estate tax would hurt charitable giving far more, many of the same conservatives who are complaining about Obama's plan scoffed at the idea that tax policy played a major role in charitable giving. Obama plans on retaining the estate tax, and raising the tax rate for large estates, which would make bequeaths to charity more valuable.