How Many Ways Can You Tax the Rich?

Rarely have the rich been so popular with Democrats. Boxed in by President Barack Obama's campaign pledge not to raise taxes on anyone earning less than $200,000, Democrats have proposed more than a half-dozen ways to target high earners to pay for a growing list of priorities, from extending health insurance coverage to 30 million Americans to covering the cost of the troop surge in Afghanistan.

Soaking the rich may appeal to the Democratic base, but tax analysts say there isn't enough money at the high end of the income ladder to finance the Democrats' wish list without imposing confiscatory rates. About 4.5 million households filed tax returns reporting $200,000 or more of income in 2007, according to IRS data. They paid a combined $610 billion, or 44%, of all federal income taxes. "It's just not possible to get the revenue you need only from this group," says Joel Slemrod, director of the Office of Tax Policy Research at the University of Michigan.

Eventually, tax experts say, Democrats will have to relent and raise taxes on those making less than $200,000, or introduce a value-added levy on goods and services, a type of consumption tax common in Europe. "There's widespread agreement that you are going to have to adopt fiscal measures that go beyond the top 2% or 3% of the population," says Alan D. Viard, a resident scholar at the American Enterprise Institute, a Washington think tank.

There's no shortage of ideas in Washington on how to squeeze more money out of the rich. For starters, the White House intends to allow some of the tax cuts enacted under President George W. Bush to expire in 2011, which will cause the top rate on income to return to 39.6% from 35%. Capital-gains and dividend taxes will go up, too. Plus, Congress may act this month to restore a tax on large estates set to lapse next year.

Prospects for other proposals are more uncertain. Momentum behind a tax on stock and derivatives trades seems to be dissipating, while a proposed 40% levy on so-called Cadillac health plans is running into opposition from labor unions, a core Democratic constituency. But two other measures have a decent shot at eventually passing: One calls for the introduction of a 5.4% surcharge on couples with income above $1 million—favored by House Speaker Nancy Pelosi—and the other would raise Medicare payroll taxes on high earners to help fund the health-care overhaul. If those were enacted, along with the expiration of the Bush tax cuts, the top marginal rate would rise to about 55% in high-tax states—a level not seen since the pre-Reagan era, according to the Tax Foundation, a Washington-based research group.

Democrats say it's only fair to ask top earners to pay more because their share of income rose while their tax burden fell disproportionately under Bush. Data released by the IRS in January showed the average tax rate paid by the richest 400 Americans fell by a quarter, to 17.2%, and their average income doubled to $263.3 million through the first six years of the Bush Administration. "They have done incredibly well," says Senator Carl Levin (D-Mich.), who is pushing for a "war tax" on wealthy households.

Yet the Democrats' tax strategy could also backfire by offering their rivals a political opening ahead of next year's midterm elections. Says Clint Stretch, a principal at the Washington consulting firm Deloitte Tax: Democrats "run the risk of really reinvigorating the Republican Party on an issue it's been able to succeed on."

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