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When taxes rise next year, will the rich avoid them?

Extreme tax avoidance could frustrate Obama's plans to trim the deficit.

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•Switching out of stocks of dividend-paying companies to other more tax-favored issues, such as municipal bonds;

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•Obtaining a bigger mortgage than originally planned to get a larger mortgage interest deduction;

•Retiring from work, perhaps earlier than planned. Or, if a household has two wage earners, one quitting his or her job to trim taxable household income.

•Opting not to start a small business.

Other experts don't expect major economic harm from higher taxes.

"Unquestionably, people will undergo a reasonable amount of tax avoidance in response to higher taxes," says Ben Harris, a senior research associate at the Brookings Institution, a Washington think tank. But he doesn't expect tax avoidance to be "so drastic that tax collections will decrease dramatically or that people will take a lower salary or stop investing."

Harvard economist Raj Chetty's estimates of long-term tax avoidance are not far from Carroll's: a 3 percent income drop for every 10 percentage point rise in tax rates. But he doesn't find that such avoidance causes broad problems.

"People have overstated the cost of raising taxes on the rich," he says. "The net effect is simply too small to show up in the economy.... GM will not produce fewer cars. Microsoft will not produce less software. Although CEOs might reclassify some income, this doesn't affect the GDP [gross domestic product]," Mr. Chetty says.

What's more, the highest marginal tax rate proposed by the Obama administration still pales in comparison with earlier top rates, some experts note. For instance, in 1944 and 1945, the top federal rate was a whopping 94 percent. Between 1971 and 1980, the highest federal rate stood at 70 percent, according to the Internal Revenue Service.

Average tax rates headed up

Of course, these marginal rates don't reflect the rate high earners pay on all their income. The more telling number is their average tax rate.

"Right now, the top 1 percent of taxpayers probably pay about a 27 to 28 percent average federal tax rate" versus the current 35 percent marginal tax rate, Mr. Giertz says. That average rate could rise to 34 or 35 percent if the Obama tax plan goes through and new Medicare taxes take effect in 2013 under the recently passed health-care law.

Add in-state and local taxes, and the "average tax rate on the top 1 percent of taxpayers could hit about 50 percent," even without the new health-care taxes, says Giertz. The rate would be even higher in high-tax districts like New York City and lower in places with no state income taxes, such as Texas.

Even these rates aren't horrific compared with some levels in the past. If the Obama plan passes, Giertz says, the top 1 percent of taxpayers would be paying "a decent amount" less than they did in the 1960s and '70s.

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