Taxing the Rich Is a Fool's Game by Drew Benson

In my last post I said, “Nothing is certain but death and taxes.”  Well, I meant to say, “Nothing is certain but death and progressive taxes.”  Mr. Obama has made it clear that taxes are going to be raised, but he plans on placing most of the burden on high income earners.  A plethora of new taxes and additional tax proposals are emanating from Washington as lawmakers look for ways to raise revenues and redistribute wealth.  Unfortunately, these taxes are sure to punish the rich, as well as the middle and working classes and will in all likelihood reduce federal tax revenues and therefore balloon the deficits further.

Tax increases are just around the corner as the Bush Tax Cuts will expire at year’s end, which will raise the top two tax rates to 36% and 39.6% from 33% and 35%.  Also, a 3.8% “Medicare Tax” on investment income, including dividends, on singles making more than $200,000 and couples making more than $250,000 will be implemented at the beginning of 2013.  Additionally, Congress is proposing further tax increases on dividends to 39.6% from 15%, giving you a grand total of 43.4%.

Unfortunately for the economy and for Congress, taxing the “rich” is a fool’s errand.  In an authoritative paper published by the National Bureau of Economic Research, Jon Gruber of MIT and Emmanuel Saez of Harvard found that a person making more than $100,000 has a taxable income elasticity of 0.57.  In other words, the “rich” are very responsive to tax hikes and will therefore seek tax shelters, move, reduce hours worked, take longer vacations, etc. to avoid the excess burden.  This inevitably reduces economic activity, and therefore tax revenues either fail to grow or they decline.  Despite the current populist outrage, Mr. Gruber and Mr. Saez found that declining marginal tax rates, or at least flat rates, are the most efficient way to raise government revenue.

In comparison the middle and lower working classes are not as responsive to tax hikes.  Because they lack disposable income and time, they will likely have to work longer and harder in order to offset the additional burden of increased marginal taxes.  In theory, if Congress wants to raise revenues they should increase rates on the lower marginal income brackets.  However, this is politically and ethically a horrible idea.

No matter how you slice it, the tentacles of tax policy can only reach so far.  Brian Riedl of the Heritage Foundation found that regardless of the top marginal tax rate, government revenues almost always come in at 18% of GDP.  Here is a chart from his article Ten Myths about the Bush Tax Cuts:  

             The only way to increase tax revenues is to find ways to increase GDP.  There are two proven ways, cuts taxes and reduce business regulation.  Mr. Obama however, has made it his personal vendetta to punish those that have “too much”.  Unfortunately for him and the economy, he is biting at the hand that feeds him.

            The increased tax burden on wealthier Americans, spearheaded by Mr. Obama and Congress, is going to slow the recovery and economic activity in general going forward.  As the wealthy become less productive, it will manifest itself in higher unemployment, lower wages, goods inflation, and higher federal budget deficits than they otherwise would have been.  Entrepreneurial activity will be distorted towards inefficient and unnecessary behavior.  Because there will be fewer economic opportunities, the real victims will be the middle and working classes.  If you are business owner, prepare for increased costs of doing business.

By:  Drew Benson

Economist, ITR