Long-run Macroeconomic Impact of Increasing Tax Rates on High-Income Taxpayers in 2013
The confluence of fiscal policy changes scheduled to occur at the end of 2012 – sometimes referred to as the “fiscal cliff” – poses serious challenges for policy makers. One area of disagreement is the increase in tax rates for high-income taxpayers resulting in part due to the sunset of elements of the 2001 and 2003 tax cuts. President Obama has called for the reinstatement of the higher top tax rates in his budget submission to the Congress, while key Republican members of Congress have called for their extension. The increase in the Medicare tax and its expansion to unearned income for high-income earners under the Patient Protection and Affordable Care Act of 2010 (PPACA) further contributes to the increase in top tax rates.
The concern over the top individual tax rates has been a focus, in part, because of the prominent role played by flow-through businesses – S corporations, partnerships, limited liability companies, and sole proprietorships – in the US economy and the large fraction of flow-through income that is subject to the top two individual income tax rates. These businesses employ 54% of the private sector work force and pay 44% of federal business income taxes. The number of workers employed by large flow-through businesses is also significant: more than 20 million workers are employed by flow-through businesses with more than 100 employees.
This report uses the EY General Equilibrium Model of the US Economy to examine the impact of the increase in the top tax rates in the long-run. While a recent Congressional Budget Office (CBO) report examined the near-term effects of all of the federal government fiscal policies under scrutiny at the end of 2012 and found them to be of sufficient size to push the economy into recession at the beginning of 2013, this report focuses on the long-run effects of the increase in the top tax rates.