The further to the left or the right you move, the more your lens on life distorts.

Monday, August 02, 2010

Tax the Rich

President Obama, most of his advisors, and many on the Left who still support his policies take it as an article of faith that taxes on “the rich” should be increased. That’s why there’s going to be a fight in Congress on rescinding the Bush tax cuts.

Those who favor tax increases have a simple rationale—we’re running a serious deficit and the “rich” can easily afford increased taxes. That in turn will help reduce the deficit by providing the government with additional revenue.

To sell their rationale to the general public, they resort to class warfare arguments, suggesting that every small business owner who is doing well is no better than a trust fund slacker like Paris Hilton or a Wall Street Master of the Universe like AIG's Joseph Cassano. They suggest (dishonestly) that the “rich” don’t pay their “fair share,” although it’s exceedingly difficult to understand how paying 70 percent of all income taxes collected isn’t a fair share. They argue that those who aren’t rich are burdened with payroll taxes, forgetting that payroll taxes are actually fee-for-service payments (e.g., Social Security or Medicare) that are made many years in advance of the service being rendered (others would argue that these payments are actually a Ponzi scheme, but that's a different discussion).

But at the end of the day, the administration’s insistence of increased taxes is bogus because the Obama strategy simply won’t work. Although it sounds counter-intuitive, history indicates that increasing taxes on “the rich” results in reduced government revenues. Economist Arthur Laffer provides some data:
Anyone who is familiar with the historical data available from the IRS knows full well that raising income tax rates on the top 1% of income earners will most likely reduce the direct tax receipts from the now higher taxed income—even without considering the secondary tax revenue effects, all of which will be negative. And who on Earth wants higher tax rates on anyone if it means larger deficits?

Since 1978, the U.S. has cut the highest marginal earned-income tax rate to 35% from 50%, the highest capital gains tax rate to 15% from about 50%, and the highest dividend tax rate to 15% from 70%. President Clinton cut the highest marginal tax rate on long-term capital gains from the sale of owner-occupied homes to 0% for almost all homeowners. We've also cut just about every other income tax rate as well.

During this era of ubiquitous tax cuts, income tax receipts from the top 1% of income earners rose to 3.3% of GDP in 2007 (the latest year for which we have data) from 1.5% of GDP in 1978. Income tax receipts from the bottom 95% of income earners fell to 3.2% of GDP from 5.4% of GDP over the same time period.

Virtually every serious economist (with the notable exception of Paul Krugman) argues that increasing taxes in the teeth of a serious recession is counter productive, removing spendable dollars from an economy that depends heavily on consumer spending.

It’s troubling that the best and the brightest in the Obama administration are so ignorant of history. Laffer provides some historical background:
The Great Depression was precipitated by President Hoover in early 1930, when he signed into law the largest ever U.S. tax increase on traded products—the Smoot-Hawley Tariff. President Hoover then thought it would be clever to try to tax America into prosperity. Using many of the same arguments that Barack Obama, Nancy Pelosi and Harry Reid are using today, President Hoover raised the highest personal income tax rate to 63% from 24% on Jan. 1, 1932. He raised many other taxes as well.

President Roosevelt then debauched the dollar with the 1933 Bank Holiday Act and his soak-the-rich tax increase on Jan. 1, 1936. He raised the highest personal income tax rate to 79% from 63% along with a whole host of other corporate and personal tax rates as well. The U.S. economy went into a double dip depression, with unemployment rates rising again to 20% in 1938. Over the course of the Great Depression, the government raised the top marginal personal income tax rate to 83% from 24%.

Is it any wonder that the Great Depression was as long and deep as it was? Whoever heard of a country taxing itself into prosperity? Not only did taxes as a share of GDP fall, but GDP fell as well. It was a double whammy. Tax receipts from the top 1% of income earners stayed flat as a share of GDP, going to 1% in 1940 from 1.1% in 1928, but at what cost?

It appears that more than a few Democratic Congressman and Senators recognize these historical truths and have begun to push back. We can only hope that the President allows reason to trump ideology and steps away from his insistence on increased taxes at a time when the economy needs stimulation, not euthanasia.