Tax Rates and Tax Revenues

We live in an Age of Unreason. Public debate seems more and more to be  controlled by those who shout the loudest and those who evince the most irrational emotions.

Witness the mindless debate over raising taxes. The Obama administration has won the argument: one way or another, taxes on the rich will be raised, supposedly to support more government programs.

People who pay very little in taxes have been more than happy to sock it to the rich, the 1% or the 2%, to make them pay what is called their fair share.

Since the 1% pays close to 40% of the taxes, one wonders what would be a fairer share.

The debate and the pending tax rate increases have nothing to do with raising revenues. They are intended to punish the rich and to inscribe class warfare in the American political system.

For people who know nothing, they exert a powerful political influence.

Writing on the Reason site, Simon Richman explains that raising tax rates does not necessarily produce more tax revenue. More often than not, higher rates produce less revenue.

The reason: the rich are not cardboard figures, dramatic personae who roll over whenever they are told to give more to the government.

In Richman’s words:

Those who are singled out for tax increases are not stationary targets. The means of avoiding and evading the taxman are legion.

U.S. government agencies routinely issue estimates of how changes in the tax code will affect the flow of revenues to the treasury. President Obama says the tax changes he has been seeking will bring in $1.6 trillion over a decade. But such estimates assume taxpayers are something other than human beings who engage in purposive action. People like to keep the money they make—why shouldn't they?—and they typically avail themselves of every legal (and not-so-legal) strategy to do so. Change the tax environment by raising rates or adversely modifying the rules, and taxpayers, especially those in the upper echelons of earners, can be counted on to modify their conduct accordingly; there's no reason to think their wish to hold on to their money has diminished just because the tax code has changed.

Or, as Kurt Hauser wrote a few years ago:

When tax rates are raised, taxpayers are encouraged to shift, hide and underreport income. Taxpayers divert their effort from pro-growth productive investments to seeking tax shelters, tax havens and tax exempt investments. This behavior tends to dampen economic growth and job creation. Lower taxes increase the incentives to work, produce, save and invest, thereby encouraging capital formation and jobs. Taxpayers have less incentive to shelter and shift income.

Janet Daley argues that the tax increase on the rich is only the first volley. Since the rich do not have enough money to fund the entitlement state, if Obama wants to stick to the one principle he seems to know, he will have to increase tax rates on the middle class.

The amount of money that is required to fund government entitlement programmes is now so enormous that it could not be procured by even very large increases in taxation on the “rich”. Assuming that you could get all of the rich members of your population to stand still and be fleeced (rather than leaving the country, as Gérard Depardieu and a vast army of his French brethren are doing), there are simply not enough of them to provide the revenue that a universal, comprehensive benefits system requires. And if all the French rich did stay put, and submit to President Hollande’s quixotic 75 per cent income tax, they would soon be too impoverished to invest in the supply side of the economy, which would undermine any possibility of growth.

Barack Obama knows that a tax rise of those proportions in the US would be politically suicidal, so he proposes a much more modest increase – an income tax rate of around 40 per cent on the highest earners sounds very modest indeed to British ears. But that is precisely the problem. If a tax rise is modest enough to be politically acceptable to much of the electorate, it will not produce anything like enough to finance the universal American entitlement programmes, social security and Medicare, into a future with an ageing population. There is no way that “taxing the rich” – that irresistibly glib Left-wing solution to everything – can make present and projected levels of government spending affordable. That is why Britain and almost all the countries of the EU have redefined the word “rich” to mean those who are earning scarcely twice the average wage, and pulled more and more middle-income people into high tax bands. Not only are there vastly more of them but they are far more likely to stand still and be fleeced, because they do not have the mobility of the truly rich.

Welcome to the future.