Dollar's demise traces roots to tax trap

Let's take the tax changes the Democrats have planned for next year. They want to let the top marginal rate go from 35 percent to 39.6 percent, and to reduce the value of itemized deductions in a way that adds a little more than a percent to the marginal tax rate, making the total 40.8 percent.

The top income tax rate kicks in for a married couple at US$372,951. Everyone with an income above that will face the higher rate, and some adjust their taxable income down accordingly.

How big will that adjustment be? A study by Emmanuel Saez, an economist at the University of California-Berkeley, suggests that these taxpayers would reduce their income by about 5.2 percent.

If incomes do decline in that amount, then the tax increases will raise very little revenue. Indeed, the breakeven point for the government is surprisingly high. For every individual who has income below about US$613,000, the government will actually lose money because of the tax hike. The 35 cents lost for every dollar of income reduction isn't offset by the roughly 6 cents gained on the income that remains.

The numbers are even worse if we analyze the 5.4 percent millionaire surtax that just passed the House as part of the health care bill. Within the top tax bracket, the lower the income, the more people there are with that income. You have to collect a lot more money from the richest taxpayers in the bracket to offset the revenue losses from those at the bottom of the bracket as they make moves to avoid the tax by lowering their income. As a result the net revenue raised by these tax changes is likely to be tiny.

That means that the tax increases that the Democrats plan to pay for their expensive programs are unlikely to raise much revenue.

The government deficit already looks like it will approach US$1 trillion a year over the next decade. But in fact, the higher tax rates, especially those that are, as in the health care bill, paired with higher spending, are going to make it worse.

When foreign investors see that higher taxes deliver little new revenue while spending soars, they will head for the exits.

The dollar will be dead, and the tax trap will have killed it.

Kevin Hassett, director of economic-policy studies at the American Enterprise Institute, is a Bloomberg News columnist. He was an adviser to Republican Senator John McCain of Arizona in the 2008 presidential election. The opinions expressed are his own.

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