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Obama Administration Will Raise Income Taxes on Middle Class thanks to 47% who paid none

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Remember the multi-part “word problems” we used to get in math class? Let’s try one.

Q: If you need $100 per day to operate a bus that carries 100 passengers, how much do you have to charge each passenger to run the bus? A: $1 each

Q: If you let 47 passengers on the bus for free, how much do you have to charge the other 53 passengers? A: $1.89 each

Q: But if you charge 43 of the 53 fare-paying passengers just $.70 each, how much do you have to charge the remaining 10 passengers to cover your costs? A: $7.00 each

Q: If 5 of your $7.00 fare customers get off the bus because the fare is too high, how much revenue do you lose? A: 35%

Q: How do you make up the lost revenue without doubling the fare for the $.70 riders? A: Um…

Sound familiar? According to the Tax Policy Center, 47% of U.S. households will pay NO federal income taxes at all for 2009. Like our bus riders, that leaves the remaining federal income taxes53% to shoulder the entire federal income tax burden. But it is far from equally distributed: the top 10% of taxpayers pay more than 70% of all personal federal income taxes. Nevertheless, some - including the Obama administration - argue they should pay even more because the tax rate they pay has declined over time with the tax cuts initiated first by Reagan and later by Bush.

But many tax shelters and deductions were eliminated in exchange for lower rates and someone paying 35% on a million dollars is still shelling out 28 times – or over $330,000 - more than someone paying 25% on $50,000. Bottom line is that the wealthy pay a higher percentage of their income, a higher portion of the total tax load and a greater absolute dollar amount. Not just on a per-capita basis - they pay more federal income taxes than everyone else put together.

This is not to evoke sympathy for the rich but rather to point out a frightening vulnerability – we are all dependent on the continued economic success of a small fraction of Americans to provide the bulk of personal federal income tax revenues. For each one that gets off the bus, it will take 10 of us to make up the lost revenue. And the government plans to further increase our dependence on them by letting the Bush tax cuts expire, raising the overall top tax rates, the rate on dividends and the capital gains tax.

But can – and will - anyone actually get off the bus? The answer is yes. The richest of the rich can expatriate to avoid taxes (as they have for decades), although the Obama Administration has promised to aggressively deal with such individuals. I agree with that. But many subject to the tax increases are not the super-rich but rather physicians and other professionals, executives and small businesses with $200,000+ incomes. With reduced Medicare reimbursement for doctors, limits on bonuses and compensation for some executives and ever tighter regulations for businesses, some will retire early, cut back on their hours or partially step off the bus in other ways to reduce their tax exposure. Still others will fall off the bus by going out of business. Is it really wise to tighten the vise in so many ways on those whom we depend for 70% of our income tax revenues? Should we be so dependent on them in the first place?

And don’t think for a moment that those making less than $200,000 won’t be affected by the increases in capital gains and dividends taxes – they apply to ALL investors, large and small alike. If you own stocks and mutual funds that generate dividends and capital gains, they will be taxed at a higher rate next year. If you sell any appreciated assets next year, they will be taxed at a higher rate than this year. But there is a way around it. By selling appreciated assets this year while the tax rates are lower and reinvesting them in asset classes with less dividend and capital gains tax exposure (such as real estate, growth stocks and commodities), you can actually pay less taxes next year despite the higher rates. And if this can work for small investors, you can imagine what the millionaires and billionaires are planning. Which is why tax increases never generate the amount of revenue planned – people find ways around them.

What about our $.70 bus riders who can’t even get one foot off the bus because they don’t have an investment portfolio to reallocate? They are the ones who will get shafted. Contrary to Obama’s campaign promises, taxes on the middle class will have to go up because they will be squeezed between lower revenues than projected from the tax increases and the 47% of taxpayers who aren’t paying any federal income tax.

And that’s the truly unfair part. The government simply can’t continue to increase spending while failing to collect taxes from nearly half the population and depending exclusively on further taxing those already carrying the system. It just won’t work and the middle-class will be left holding the bag. The message of “spreading the wealth” is popular but unfortunately has never worked when translated into tax policy. We need to get a grip on spending and we need to make sure everyone pays their fair-share. No one in their right mind believes that 47% of the population is so destitute that it shouldn’t pay any income tax. Nor should they believe that the rich will sit back and watch their taxes skyrocket. It’s always easy to agree that the other guy’s taxes should increase, but believe me – you and I are the other guy.

I will leave you with these two tidbits:

A new Gallup Poll finds 48% of Americans saying the amount of federal income taxes they pay is "about right," with 46% saying "too high”. Well yeah, with 47% paying nothing, I would expect that many to say “about right.

Also, a letter to the editor that appeared recently in Wyoming:

“I object and take exception to everyone saying that Obama and Congress are spending money like a drunken sailor. As a former drunken sailor, I quit when I ran out of money. “ Amen!