How taxes on the rich get paid, by you

The Obama administration held true to the campaign promise of raising taxes on the rich. Now we've really started to take a whack at the Federal budget deficit by introducing new revenue, right? Not quite.

In recent days the yield on the 10-year Treasury bond has gone from around 1.75% to about 2%. What's the significance of that? Well, taxes went up on people making over $400,000/year. For many, a chunk of that income comes from interest on things like 10-year Treasury bonds. When the government raised taxes on that income, they lowered the net return, which lowered the value, hence higher rates. So how did the Treasury fare in this exchange?

Well, if you bought a $1,000 bond at 1.75%, over a year you'd get $17.50 in interest paid by the Federal government. You'd pay $6.30 in taxes at the old 36% tax rate. Now if you buy a $1,000 Treasury bond at 2%, you'll make $20 in a year and at the new tax rate of 39.6%, the Feds will take back $7.92. So, when you compare the net cost of borrowing for the government (interest paid, minus taxes received) their borrowing cost on that $1,000 actually went up by 88 cents. The effect is not immediate of course. They'll come out ahead on debt already issued, but on new debt, they're actually losing money on the deal. This from a scheme that was supposed to address the government's debt problem.

The wealthy also have options when it comes to income and the rate at which it's taxed. They can move investments around. Even in Treasuries, they can buy bonds with the coupons (interest payments) removed (they're sold off to other investors, money market funds, mutual funds, etc). Without the coupons, the net return is no longer income, but a capital gain, which is taxed at a much lower rate. They can also switch from Federal debt to local or state debt, which is not subject to Federal taxes.

The greeter at WalMart doesn't have these kinds of options. If your taxes go up, you pay them and that's that. The new deal did nothing to address the deficit and the ballooning national debt. It's going to get dealt with one way or the other. You'll pay in either higher taxes or by way of massive inflation. Maybe you'll get lucky and the party wont come to an end until after you're gone. In that case, your kids and grandkids will pay.

The moral of the story? There is no good way to pay for a bloated, out-of-control government. If you want to make it better, all you can do is make it smaller.