Paying their fair share

We can all breathe a sigh of relief. Those individuals making over $250,000 will finally be required to pay their fair share. Let's examine a partial list of the upcoming changes.

The tax rate in the 35 percent bracket will adjust upward to 39.6 percent. The Medicare tax will increase for all taxpayers from 2.9 to 3.8 percent. The tax is now expanded to include unearned income (previously exempt) such as interest and dividends. The president may believe that unearned income produces itself but most invested money was once earned income and was subject to Medicare taxes at that time. Government certainly benefits from taxing in perpetuity but it precludes any alternative uses of the money. More on those alternative uses later.

The capital gains rate will increase from 15 to 20 percent. While it is a sensible adjustment when considered against the 29 percent Mr. Obama proposed during the campaign, it will hardly spur new and aggressive investments.

In a truly misguided effort to increase revenues, the deductibility of charitable contributions by the wealthy will be limited. All such contributions that qualify as itemized deductions will be exempted from taxation at the rate not exceeding 28 percent.

It works like this. Under the old rule, a taxpayer earns $290,000. He contributes $40,000 to the Red Cross and cancer research. If he contributed nothing to charity, he would owe $15, 840 in federal taxes on that $40,000. To promote charitable giving, the tax is essentially waived and the taxpayer is now voluntarily $40,000 out of pocket. Under the new policy, the same taxpayer would be exempted from $11,200 of the tax and would owe 11.6 percent or $4640. The benefactor would be paying a fee of $4640 in taxes for the privilege of giving away $40,000. In other words, it now costs $46,400 to give away $40,000. Will this promote public charity?

A little noted change in the health reform bill will increase the threshold for deductions of out-of-pocket medical expenses from 7.5 to 10 percent of adjusted gross income. Should the taxpayer have $100,000 in adjusted gross income and $17,000 in qualifying physician, hospital, nursing and drug charges, only those expenses exceeding $10,000 (10 percent) are deductible. So income is reduced by $7000 and the $10,000 excluded from the deduction is taxable.

This change is manifestly counterproductive. The people who pay their own medical expenses are not the problem. Why would you punish them further by taxing them on their expenses?

Back to the alternative uses of the money. The wealthy spend their money not so differently than the poor or the government. It goes for medical care, education, investment, charity and consumption. When the government spends money, there is no guarantee that they will put it to more productive uses than private citizens or spend it more judiciously.

The justifications for targeted tax increases usually center on relative wealth inequalities. But this is hardly the only consideration. The creation of wealth entails hard work and exposure to risk. There is less incentive to work hard and suffer risk when we don't own the financial reward. Simply put, incentives matter and they are hard to locate in the administration's strategy.

You may feel little common bond with those nameless wealthy individuals and their disparate tax treatment. Or, they may be the people who don't hire you in 2011.