AMERICAN.COM

If you want an economy that is built to last, you a) don’t tax the heck out of capital and b) don’t give a massive edge to debt financing over equity financing, as the financial crisis showed.

But that is just what the United States does—and it is going to get worse. As a new study from Ernst and Young shows, taking into account both the corporate and investor level taxes on corporate profits and state level taxes, the United States has among the highest integrated tax rates among developed countries. And under President Obama’s current tax plan of letting the Bush tax cuts on capital expire—not even counting Obama’s Buffett rule—here is what happens next year:

•    The current top U.S. integrated dividend tax rate of 50.8 percent will rise to 68.6 percent in 2013, significantly higher than in all other OECD and BRIC countries.

•    The current top U.S. integrated capital gains tax rate of 50.8 percent will rise to 56.7 percent in 2013, the second highest among OECD and BRIC countries.

And why is this is a bad thing? Pay attention Obama White House and Occupy people as E&Y explains:

Most developed countries provide relief from the double tax on corporate profits because it distorts important economic decisions that waste economic resources and adversely affect economic performance. It discourages capital investment, particularly in the corporate sector, reducing capital formation and, ultimately, living standards. It favors debt over equity financing, which may result in greater reliance on debt financing and leave certain sectors and companies more at risk during periods of economic weakness. A tax policy that discourages the payment of dividends can impact corporate governance as investors’ decisions about how to allocate capital are disrupted by the absence of signals dividend payments would normally provide.

This next chart shows just how biased the U.S. tax code is in favor of debt, a tilt the Obama tax plan would make even more extreme:

What should we be doing instead? AEI’s Alex Bill recently put forward a plan that would, among other things, a) phase down the corporate tax rate to 25 percent, b) curtail the inducement for excessive financial leverage and reduce the tax code’s bias in favor of debt by disallowing 10 percent of corporations’ interest expense deduction, and c) improve the tax treatment of investment by making permanent the 50 percent bonus depreciation provision now in effect but scheduled to expire at the end of 2012.

And a group of AEI economists recently drafted a total tax code overhaul where, first, households would not pay tax on interest, dividends, capital gains, or other income from saving. Second, firms immediately could deduct business investments, rather than depreciating them over time. Such changes could boost long-run U.S. economic output by more than 6 percent.

More investment, less debt. That is how an economy is built to last.