Why Taxing the Rich May Be a Smart Move

Here's why, in a fragile economy, the wealthiest may be a good source of new revenue.

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It's well known that a major sticking point in the battle over the fiscal cliff is whether to raise taxes on the richest Americans. President Obama has often repeated his view that Bush-era tax cuts should expire but only on those households making $250,000 or more. House Speaker John Boehner, meanwhile, has repeatedly shot down that idea, instead suggesting "cleaner, fairer tax code," with fewer loopholes and deductions, though he has not given specifics on which he would eliminate.

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There's any number of ways negotiations could play out—both sides seem to be warming to the idea of raising revenues without raising rates by broadening the tax base—and it's possible that "cleaning up the tax code" could end up landing disproportionately on wealthier Americans anyway (as our own Rick Newman pointed out last week). For example, one tax reform proposal outlined in the Simpson-Bowles report proposed (among other things) eliminating the mortgage interest deduction on second homes and taxing capital gains at ordinary income rates—ideas that would likely affect wealthier earners.

If the wealthy do end up bearing more of the burden, that could be a good thing. Taking tax dollars from the rich tends to be less detrimental to the economy than putting more of the burden on people who earn less, according to economists.

"Changes in tax rates have a bigger impact on the economy for people that are lower on the income scale," says Craig Alexander, chief economist at TD Economics. "And it's a reflection of the fact that people with less money save less, so if their taxes go up, it has a greater impact on spending."

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It's the same reason why many economists believe that GDP gets a bigger boost from unemployment benefits and food stamps than from certain tax cuts: People receiving those transfers tend to need (and spend) the money.

"The economic impact of tax cuts of people on the top is much smaller than for people on the bottom," agrees Brian Kessler, economist at Moody's Analytics. However, he acknowledges common arguments as to why this might discourage growth.

"The argument against that is there's this sort of long-term effect that is disincentivizing investment, disincentivizing risk-taking, disincentivizing work," explains Kessler.

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While some believe that higher taxes on the rich would therefore mean a major hit to jobs, Kessler is skeptical.

He points to the fact that tax rates on the highest-income taxpayers have fallen dramatically over the last few decades. According to the Congressional Research Service, the average rate paid by the top 0.1 percent of taxpayers fell from more than 40 percent in the early 1980s to around 25 percent in 2009. Despite that decline, he says, "we haven't seen a significant change in the job creation rate or a significant change in new business creation."

However, it's important to be clear that raising taxes on anyone still can impede growth. Less disposable income for anyone, be it Donald Trump or a minimum wage waitress, can mean less spending or investment. In a fragile economy, the United States of course needs whatever boost it can get. And that is what makes the fiscal cliff so scary, says Alexander. To go over it, he says, would be "unambiguously bad."

"The fact is the U.S. economy is still fragile. Every time there has been a significant shock, economic growth has stalled," he says.

Danielle Kurtzleben is a business and economics reporter for U.S. News & World Report. You can follow her on Twitter or reach her at dkurtzleben@usnews.com.