As we approach the fiscal cliff, the primary idea for solving this problem from the Left is the same idea we always get from the Left: raise taxes on the “rich”. The idea is simple: All these people who make a million or more per year don’t need all that money, and won’t miss it if we take a little more of it, and all of that money will be put to good use by our uber-efficient federal government. (I presume your sarcasm detector was working for that last bit.) So we’ll just raise the top income tax rate and get more money.
For now, let’s not worry about what would happen to the money once it gets in government’s hands, because that actually isn’t the issue here. The question is: Is this actually going to result in significantly more tax revenue coming into the government in the first place?
In examining this, we have to keep one thing in mind: Not all millionaires are alike. The people that the top marginal tax rates affect can generally be grouped into five different categories, although there is much crossover from one to another. Let’s go down the list…
1) Small Business Owners
Small business owners often file as a “Sub-chapter S Corporation” which allows the owner to pay the company’s taxes as though the business were an individual and the business’s profits were its income. This allows them to pay less than if they had to pay at the corporate tax rate. Generally speaking, a small business’s profits aren’t just going into the owner’s pockets, though; that money is used to either grow or sustain the business into the future.
So what happens if we raise taxes on them? Well, businesses that want to use profits to grow won’t be able to grow as much, and businesses that use their profits to sustain won’t be able to sustain as much. The latter results in reductions in employee benefits or reductions in employees, and in some cases, businesses go under altogether. That results in less competition, which is bad for the consumer.
Basically, any good you get out of more taxes from these companies is offset by the lack of taxes you’ll get from the laid-off employees and no-longer-existing businesses. And you can forget about more jobs or economic growth. So that’s one strike against the idea of raising the top tax rate.
2) Those Who Know The Ins and Outs Of The Tax System (or Have Advisors Who Do)
It is undeniable that we have a very complex tax system in this country. Anyone who makes more money than they actually need at any given time can usually find some sort of investment strategy or tax “loophole” to shelter their excess money from taxation. Sometimes it is in the form of a pre-tax investment – such as a 401(k) – where taxes are deferred until a later date. Other methods may vary as well, as the number of different ways to do this are too numerous to count and explain here. Generally, the drawback for them is that it puts the money someplace that they can’t spend it, but they don’t need to. The point is that when you have more money than you need, there are methods to protect it. The Left will cry foul at this, but if you show me a rich liberal who complains about someone using these techniques to shelter their earnings, I’ll show you a rich liberal who is doing the same thing himself. Funny how that tends to work.
So what happens to this group when you hike the top tax rate? It just gives them even more incentive to hide their money*. In other words, you’re not going to gain much of anything from this group, either.
3) The Long-Term Investor Class
This is the group of people that includes people like Warren Buffett, who not too long ago suggested that the top tax rate should be hiked because he could afford to pay more in taxes, and he was paying a lower tax rate than his secretary. The idea eventually became known as the “Buffett Rule”**, and the Left celebrated the idea that a rich person would be so magnanimous. All rich people should be like that!
Of course, Buffett was being a giant weasel, as most rich liberals tend to be.
The fact that Buffett’s “effective tax rate” was lower than that of his secretary is based on the fact that most of his income comes from capital gains (which are taxed at 15%), and he pays himself $100,000 per year from his investments (taxed at the top marginal rate of 36%). The end result is that his secretary pays a higher “effective tax rate” because she doesn’t have the options that he does.
Of course, what this means is that an increase in the top income tax rate would have no effect on Buffett at all, because it is the capital gains rate that affects him and people like him in this group. Now if you want to talk about the capital gains rate, that’s a different argument altogether, but suffice to say that this rate is lower primarily to give people incentive to invest and take risk. Raising that rate doesn’t help a poor economy, either.
Back to the main point: Raising the top rate doesn’t net any significant money from this group, either, because very little of their money ends up getting taxed this way.
4) The “Someone Else Pays Me” Group
Generally speaking, most of the people that are earning a million dollars per year or more are doing so either by investing or running their own businesses, and are thus profiting from the growth they are creating. Relatively speaking, there are very few people who are actually paid a million dollars or more per year by someone else simply for performing a particular service, but there are a few: professional athletes, Hollywood actors, and a few in the higher levels of large companies are some examples.
For the most part, the latter group are people who understand business well enough to know what to do with that money once they earn it, i.e. they join groups two or three. Most of the others also have some sort of financial advisors helping them figure out what to do with their money (which again means they join groups two or three), but there are a few who actually act exactly like liberals seem to expect every millionaire to act: they don’t pay any attention to what is happening to their money and just pay the higher tax rate, thinking that they’ll always get more. Often times, these are the people you see in documentaries on “E!” ten years after their fame has dried up, where we learn about how they squandered their wealth and are broke now. (And if drugs were involved – which they often are – you can bet that the dealers weren’t paying sales or income taxes on those transactions, either.) They are also the most famous examples of rich people, which aids the perception that all rich people are like this.
All speculation aside, increasing the top tax rate would have the intended effect on these people, but they are few and far between, because as noted, the smarter members of this set put themselves in groups two or three.
5) The “How Did I Get So Lucky?” Group
These are people whose income is insignificant next to their wealth, which they generally came into through no effort of their own. Either they inherit it (like MN Governor Mark Dayton or any Kennedy at random), or they marry into it (like John Kerry). Not all of them end up being liberal politicians, of course, but I cite them for a reason. Some of these people don’t know how the money was made in the first place (though politicians generally do), and sometimes they feel guilty that they got so lucky and like to assume or pretend that every other rich person got lucky, too. Dick Gephardt used to refer to rich people as “the winners of life’s lottery”, as though inheritance or luck is the only way people become wealthy.
Most of the time, these people are also in groups two and three, but they need to have their own group to highlight them, because the ones who end up in politics are also the people who have some say in what the tax rates actually are. More to the point, it needs to be highlighted that these people could honestly not care less about what the tax rate is, because it doesn’t affect them a bit. Even if they weren’t putting their income in places where it is sheltered from the current tax rate, it wouldn’t matter if you taxed their income at 100%, because they can (and often do) simply live off of accumulated wealth. So it’s very easy for people like this to talk about how they would have no problem paying a little bit more, because it’s not like their income actually matters to them. The problem is that it matters to a lot of other people. Again, though, most of these people shelter their income by other means, which makes their posturing even more hypocritical, although it helps them politically. Much like Warren Buffett, people think the rich liberal politicians are being generous, when they are actually being giant weasels.
So when you look at what happens to these five groups, you either end up with negative economic consequences, more people taking their money out of the economy, or no meaningful effect at all.
So what good would raising taxes do? Well, it would make some liberals feel better. That’s about all, though.
* – This partially explains why the idea of simplifying the tax code by lowering rates and eliminating loopholes helps increase revenue: you want to give the people who have the extra money less incentive to hide it and more incentive to put it directly into the economy where it does more good. You get more revenue and more growth this way.
** — The final analysis of the benefits of the “Buffett Rule” indicated that the net gain in tax revenues from it would be less than $5 billion, and that’s only if you assume no economic impact from raising taxes on business owners and investors. In other words, it would be enough to run government for 12 hours. This shows that the “Buffett Rule” and other such tax increases aren’t about deficit reduction at all, they are simply about class warfare. If you want a really good example of what it would take to raise enough revenue to take care of one year of current government spending, check out Iowahawk’s “Feed Your Family On $10 Billion Per Day“.