While higher tax rates can discourage investment, “whether or not we actually see significant changes in behavior from small changes in tax rates is another story,” said Joe Rosenberg, research associate at the bipartisan Tax Policy Center, which analyzes tax policy. “We do see some, but the magnitude is probably fairly small.”
Part of the dispute is grounded in politics. Obama made raising rates on the wealthy a keystone of his re-election campaign. For two decades, Republicans have made opposition to higher tax rates their party’s mantra. Neither side is eager to surrender.
The present faceoff is also a tactical duel ahead of an even larger war over revamping the entire tax code that could come next year. Both sides know that if tax rates on the wealthy rise now, it will be harder to push them back down later.
In addition, the battle underscores ideological differences in the two parties’ constituencies.
Republicans say raising tax rates on high-income Americans discourages investments that would produce new jobs.
“Here’s how Republicans think,” said Kenneth Kies, a former top House GOP tax aide and now a tax lobbyist. “If I’m a risk-taker and I’m getting ready to invest $1, if I’m successful and the top rate is 35 percent, I get to keep 65 cents.”
If the top tax rate is much higher, Kies said, he would get to keep less “and my incentive to invest is significantly reduced.”
For Democrats, imposing higher tax rates on people making the most money is a fair way to make them contribute to deficit reduction. They say Obama would merely return rates to levels that existed under President Bill Clinton, and the economy prospered then.
Because various tax breaks have such powerful defenders — for example, charities, churches and colleges — it’s politically difficult to limit them. The subsequent search for revenue could expose the middle class to higher taxes, Democrats say.
During the presidential campaign, Republican nominee Mitt Romney suggested limiting itemized deductions to a dollar cap, such as $25,000. The nonpartisan Tax Policy Center estimates that capping deductions at $25,000 would raise $1.3 trillion. But 29 percent of it would come from those earning under $200,000, whose taxes both parties say they don’t want to increase.