The great debate over closing the budget deficit continues in our nation’s capital and across the country. Options boil down to:
• Reducing civil servants’ future medical and pension benefits
• Reducing Medicare and Medicaid payments
• Reducing military spending
• Closing tax loopholes and reduce “tax expenditures”
• Increasing taxes for the rich, of course.
In this and future posts we shall endeavor to provide solutions to America’s fiscal problem that are not only fiscally sound, but politically practical. Staying with the theme of my website, let’s start with the last point first: taxing the rich.
Is it “fair” to tax the rich at a higher tax rate? Or is it shortsighted? When we say a higher tax rate we mean the higher your income, the higher the tax rate on the incremental income. This higher tax rate is referred to as the marginal tax rate.
As I was launching this blog in the winter of 2011, the Obama administration cut a year-end 2010 deal with the Republicans that extended the Bush-era tax cuts for an additional two years on all income brackets including the “rich.” This tax cut extension was clearly a victory for the “Tea Party” politicos. The tax extension, now the “Obama tax cuts,” created a great outcry in the liberal press and much of the Democratic Party. The general view in the press and the Democratic Party is that it is very unfair not to tax the rich at a higher marginal rate. Responding to this, President Obama has now started campaigning for the next election on a platform of increased taxes on the rich.
Among the various justifications given for this higher taxation, two stand out. First, the country needs the money. Second, the rich have the money. With apologies to the famous bank robber Willie Sutton, these arguments sound like him. In his autobiography Willie says "Go where the money is...and go there often." [1]
Why do so many well-intentioned people, many highly educated, believe it is right, fair and moral to tax the rich more? Even many rich people espouse this view. [2]
To put the idea in context, let’s examine the proposition in a slightly different manner. In our society, many hourly workers, union and non-union, receive time–and-a-half or double-time for working weekends, holidays or double shifts. In other words, our society quite rightly recognizes that this additional, incremental or marginal work should be paid at a higher rate. Why? Because it is “fair?” Not at all: these workers are paid a higher incremental wage because they must be provided an incentive to work longer hours. In a similar fashion, well-run businesses have long recognized the necessity of paying those talented and hardworking employees higher salaries, bonuses and stock options. Do these companies pay these workers more because they are trying to be “fair?” Of course not! The higher compensation is paid to attract and retain the most talented, hardworking employees the company can afford.
It is quite obvious that a company, or any organization, that wishes to keep its best employees must compensate them in such a manner that the harder and smarter they work, the more income and/or benefits they earn. In other words, the more the employee contributes to the success of the entity, the more management must compensate that employee or risk losing him or her. This practice is not only smart business, it is absolutely considered “fair” by most members of our society.
Is government any different? With respect to its citizens, it is subject to the same laws of economics: compensate the best or lose them. I am not talking about the individuals the government hires as civil servants, but rather the citizens who work and pay taxes. The government does not manufacture products or provide services that earn a competitive return in the normal way of the marketplace. It must acquire its “revenues” or “sales” from those productive citizens who choose to live within its jurisdiction and be taxed. These citizens are, if you like, not only employees of their companies or entities; they are also, by virtue of the income taxation system, “employees” of the government. In fact, a school of thought within the liberal intelligentsia believes that all money earned by the citizens belongs to the government and that any money the citizens are allowed to retain is a “tax expenditure.”
Why do many people in and out of government deem it “fair” to discriminate against the citizens who work hard and by virtue of this hard work, earn more money and thereby are taxed at a higher marginal rate? Higher marginal tax rates have no basis in morality or fairness except for the fact that “rich” people have the money; the rich are like the banks Willie Sutton robbed. I believe it is pure envy of the income and wealth earned by the hardworking members of society that motivates the taxation (theft) of those earnings by the left and left-leaning political class. Yes, I know there are arcane academic arguments that rich people value the marginal dollar less than the first dollar, but so what? They still earned it.
Going back to my wage-earner example, high marginal tax rates are also very harmful to society at large in exactly the way they are harmful to the private economy. Just as companies lose their most productive employees if they do not compensate them appropriately, governments lose their taxpayer base.
Governments lose their taxpayer base when their tax rates become uncompetitive. Analysis of the movement of people from high tax states to low tax states demonstrates this point. It can also be observed as our rich citizens relocate their domiciles, both personal and corporate, to low-tax countries. [3], [4], [5] States and the federal government have passed laws trying to make the movement of personal and corporate domiciles complicated and expensive, but move they do from high-tax states and countries to low-tax states and countries.
Given their added resources, the rich have found many ways to avoid higher tax rates. The easiest method is to simply trade off monetary income for non-monetary income; in other words, they work less and vacation more. Being influential, they also encourage the passage of laws that allow them to shift income to lower-taxed categories or to shelter the income from taxes. Congress is eager to provide these tax shelters because of the potential for future campaign contributions (Read campaign contributions and post-congressional careers at high salaries). [6]
It is useful to remember that quite often the rich are better educated, more intelligent, work harder, are better connected and more driven to succeed than the average person in society. They can afford the best accountants and tax attorneys. [7] In short, trying to tax the rich in the manner proposed by the liberal political class demonstrates its lack of understanding of the rich.
Fluctuation in capital gains create another hole in the theory of taxing the rich at a higher marginal tax rate to obtain revenue. The rich make most of their income by way of capital gains. However, capital gains wax and wane with economic activity and the financial markets. Thus, when governments obtain much of their revenue from this very small percentage of the population, they find that their tax revenue is highly unstable. [8]
So, how do we harness the rich to most usefully employ their great human capital, financial capital, and creative and entrepreneurial energy to benefit society at large? A society does this by providing a rule of law, a fair and transparent judicial system, sound money, respect for private property, free and transparent markets, transparent government with minimal regulation, and a fiscally responsible government with the lowest taxation possible. It sounds easy and obvious but it is not.
Political corruption by both elected and appointed government officials proceeds unabated in America today. The United States is fiscally irresponsible and survives on fiat (paper) money that is unsound. Just as individuals must spend less than they earn to accumulate wealth so must the United States. The United States has had a long run of growing budget deficits, increasing debt, and increasing promises to the population like social security, Medicare, Medicaid, and other welfare transfer programs. We provide subsidies for ethanol, sugar, other agriculture and numerous forms of welfare for corporations and the middle class. Finally we have an interventionist State Department and military that spend huge sums of money interfering in other countries’ affairs. By any normal measure of accounting, our country is bankrupt.
Many people have lost faith that America can ever achieve a sound and growing economy, given our hopelessly complicated and corrupt taxation system and our manifestly unsound fiscal and monetary policies. These people are probably correct, but the sheer challenge of trying to design a politically practicable solution is one we would like to undertake. We don’t expect to change the world, only to have a lot of fun thinking through the problems.
Here is the plan. We will approach the problem the same way we do with individuals who are in financial difficulty. There are three legs to the stool: a revenue plan, a spending plan and a “clean up your act” plan. To an individual we might say, “Get a job, spend less than you earn, and cut up your credit cards.” Most individuals are more prudent than the United States Government.
We welcome your thoughts as we go along.
[1] Where the Money Was: The Memoirs of a Bank Robber (Viking Press, New York, 1976 Accessed from: http://en.wikipedia.org/wiki/Willie_Sutton on December 12, 2010.
[2] Warren Buffet and Bill Gates are constantly singing the praises of taxing the rich more. Since they are the two richest men in America the implied view is that we should listen to them. The fact that the tax laws favor them greatly and the bulk of their fortunes will permanently go untaxed is reason enough to ignore them. We should encourage them, and other like-minded individuals to publically and voluntarily donate a large part of their fortune to the U.S. Treasury and stop trying to get laws passed to tax others who do not believe the way they do.
[Accessed March 18, 2011]
[3] Individuals and businesses have been moving from one political or taxing jurisdiction to another for most of recorded history. The reasons for moving are often for political or religious freedom; for economic freedom; and for more economic opportunity. A good discussion of the history of this movement can be found at: http://en.wikipedia.org/wiki/Brain_drain [Accessed March 18, 2011] [4] There are plenty of examples of states that have raised taxes on the rich only to lose their rich citizens to other states:
[Accessed March 18, 2011]
[5] Eventually the movement of individuals from high tax jurisdictions to low ones affects the politics of the area; this is happening now in America:
[6] Playing the Tax Break Game-It helps to have a friend on the mighty Senate Finance Committee where no favor is too small, by Jonathan Salant and Greg Giroux, Bloomberg Business Week, April 11-April 17,2011, page B18
[7] The More You Make The Less You Pay-The Billionaire’s Guide to Paying No Taxes, by Jesse Drucker, Bloomberg Business Week, April 11-April 17,2011, page 45
[8] The Price of Taxing the Rich, Robert Frank, Wall Street Journal, March 26-27, 2011, page C5
Labels: Opinion