Inefficient impost

The latest attempt to tax America’s richest citizens looks highly counterproductive. Democrats in the Senate are now touting a 5.6 per cent millionaire’s surtax starting in 2013. The higher marginal rate would encourage avoidance and risks dinging the already ailing economy.

Under the circumstances, imposing a greater burden on the wealthy makes sense – but only up to a point. To fund his $450 billion jobs proposal, President Barack Obama wanted to cap the value of itemised deductions at 28 per cent for married couples earning over $250,000.

His scheme would partly repair a dubious element of the tax code and help pare deficits without excessive pain. Though it would also hit less wealthy folks, a truly well-off New Yorker, for example, with $5 million of adjustable gross income, of which $1 million was from capital gains and $500,000 of deductions, would have to pay about $80,000 more in taxes.

The Senate proposal, which Obama said on Thursday he is “comfortable with,” taxes the ultra-rich more steeply. The same individual earning $5 million would pay an extra $220,000 to the taxman. Non-millionaires would be exempted, which may help the measure garner greater support. But there is an added burden.

Including Medicare and state and local levies, the marginal tax rate for top earners would grow to an uncomfortable 56.3 per cent. In low-tax states, it would jump over the psychologically important 50 per cent threshold. And that’s where it starts to get dicey.

While tax hikes at low levels change taxpayer behaviour only modestly, higher ones have a greater effect. Nobel prize winner Edward Prescott, for example, showed how marginal tax rate differences could explain most of the reason why the French labour supply is so much lower than that of the United States.

When taxes reach such heights, it also spurs greater avoidance efforts. That would make offshore centres like Singapore more appealing.

The millionaires who stick around could opt for earlier retirement or shift more of their investment to tax-free, low-risk alternatives like municipal bonds. That would all undercut the revenue anticipated by the Senate plan.

Before embracing the surtax, lawmakers may want to consider that targeting millionaire golden geese too aggressively can reduce the supply of golden eggs.