By Stephen P. Diamond, Jr.Progressive Blogger/Street Sweeper.com/Attorney

Last week, millions of Americans were surprised to discover that they are rich.

Well, not really.

But under President Obama's proposed budget, many taxpayers earning more than $200,000 a year ($250,000 for married couples) and less than $500,000 have suddenly found themselves lumped together with the likes of Stephen Schwarzman and Donald Trump, even though they don't own a private jet, live in a baronial mansion or bring Rod Stewart in to sing for them at their birthday parties.

The only problem is that the HENRYs are not rich.

As Tully explains, "'Rich' means personal wealth, or net worth, not income." Raising taxes on HENRYs at a time when much of the value of their assets--their homes and retirement portfolios--has evaporated, could have unintended negative consequences for the economy and the president's plan for recovery. Why? Because the HENRYs are big spenders. They are "the bulwark of the professional and entrepreneurial class that drives the economy," writes Tully.

He's not kidding. A 2007 HSBC Direct Consumer Survey found that people earning between $50,000 and $100,000 save more regularly than people earning between $200,000 and $250,000 per year, and revealed that 49% of respondents earning at least $250,000 a year failed to save more because they "want some spending money."

On top of their discretionary purchases, HENRYs carry significant mortgages, pay heavy property taxes, make charitable donations and sock money away for their children's college education.

Under the president's plan, beginning in 2011, HENRYs would see their federal income tax rates rise from 33% to 36% and, in the highest tax bracket, from 35% to 39.6%. More importantly, the president's plan would reduce the amount of mortgage interest and charitable donations that HENRYs could deduct for income tax purposes, from 35% to 28%.

Faced with declining asset values, tough economic times and higher tax bills, HENRYs will very likely rein in discretionary spending this year and next.

That's bad news for a consumer-driven economy like the United States, which saw consumer spending in the fourth quarter of 2008 plunge to a 26-year low. But reducing mortgage interest deductions makes even less sense when the federal government is trying to reverse or at least stabilize falling housing prices--which, lest we forget, is how we got into this mess in the first place. One of the main incentives for HENRYs to buy a house (or anyone else for that matter) is that they can deduct more than a third of their annual mortgage interest payments from their adjusted gross income. Why buy a house when taxes are climbing and the housing market is tanking if the government is removing your ability to afford the payments?

In fact, the president's decision to squeeze more taxes from HENRYs is pregnant with potential negative consequences.

Dual income families, in which one spouse's salary is just below $250,000 and the other's is significantly less, may decide that the increase in their marginal tax rate negates the benefits of the second salary , when combined with existing high childcare expenses. Many of these families could move to cut their tax liability and expenses by having one parent stop working to raise their children. Childcare companies would see smaller revenues, household spending would decrease and the U.S. labor force would contract even further (both from parents leaving the work force and childcare company lay offs), to name just a few possible ramifications.

If higher income taxes force HENRYs to cut back further charitable organizations, public school systems (many HENRYs send their children to private schools), automakers and other public and private sectors of the economy will pay the price. Such unintended consequences would work to counteract the potential benefits of the economic stimulus package the president signed last month.

I applaud the president for ramming through a massive stimulus package to kick start the economy into recovery. But his idea to fund it by raising taxes on the very people who will need to pick up where the stimulus package leaves off, is myopic and dangerously misguided.

Japan proved during its so-called "Lost Decade" that raising taxes during an economic downturn has a negative effect on consumer spending. "To counter mounting debt created by government stimulus packages," observed former Secretary of the Treasury (and State) James Baker in Monday's Financial Times, "Japan increased taxes in 1997. Consumption dropped and the country's economy collapsed."

The Japanese experience holds an ominous warning for President Obama.

Make no mistake--high net worth Americans (i.e., the truly rich) can afford and should pay higher taxes. But the president has cast too wide a net in his attempt to capture the big fish. Under his plan he will also trap the smaller ones that need to be let go. His recovery can't work if he follows his current plan. Unless he wants his economic initiatives to fail, he should let the HENRYs go.

Sources for this post:

Shawn Tully, Obama's Shock to Six Figure Earners, Fortune, February, 27, 2009.

James Baker, How Washington can prevent zombie banks, Financial Times, March 2, 2009.

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