Archive | February, 2019

Why taxing the wealthy in the US at 70% of income is a very bad idea.


This issue raises a couple of subsidiary questions:
1 Firstly, will the wealthy pay more tax as the plan assumes?
2 Secondly, will the economy of the country grow faster?
3 In any of these scenarios, who is likely to harmed, the rich, the poor or both groups?
As to the first question, let’s consider history. There have been three major tax cuts in the modern American era, four if you add that of Trump. As the latter is rather recent, we can ignore it for the moment.
The first tax cut was in the early twenties, when the top marginal rate was cut from 70% to 25%. The result was that tax revenue rose from $719 million in 1921 to $1164 million in 1928, an increase of more than 61%. In the same period the share of the tax burden paid by the rich rose from 44.2 percent in 1921 to 78.4 percent in 1928.
In the Kennedy era top taxes were cut from 90% to 70%. That had the effect that tax revenues climbed from $94 billion in 1961 to $153 billion in 1968, an increase of 62 percent (33 percent after adjusting for inflation). The relative burden of the wealthy rose from 11.6 percent to 15.1 percent.
Ronald Reagan introduced a dramatic tax cut in 1983. This was followed income tax revenues rising dramatically, by more than 54 percent by 1989 (28 percent after adjusting for inflation). The share of income taxes paid by the top 10% of earners jumped significantly, climbing from 48.0 percent in 1981 to 57.2 percent in 1988.
Tax takings probably rise after a tax cut because taxpayers paying low taxes have less incentive to evade or avoid taxes, and because they have more incentives to produce, as their take-home income increases the less tax they are liable for.
What about growth?
In the years following on the twenties tax cut (1921-28) the GDP of the US grew by 42% in real terms. Between 1961 and 1968 it grew by 43%, and in the Reagan years by 28%.
In each case GDP growth more than doubled compared to the equivalent preceding period.
Here is summarised data of a list of wealthy countries (countries with per capita GDP over $20 000, chosen at random but omitting oil economies), setting out their average tax burden per quartile as a percentage of GDP, together with percentage change in GDP over a 10-year period and the size of their government debt:

The low-tax countries outgrew the high-tax ones by a country mile. This confirms the theory that the more the government takes money out of the economy by way of taxes, the less it grows. This would be explained by the fact that taking wealth out of the productive private sector and allocating it to the unproductive state sector reduces productivity of that wealth, and hence growth. It is further explained by incentives: by punishing citizens for earning income, the state creates a disincentive to produce. It should be added that if this confiscation disproportionately affects the rich (as is usually the case and certainly in terms of the current proposal) , the normally most productive section of the economy is harmed most.

As for the argument that a low tax burden will cause government debt to grow, it is clearly not the case based on the above figures. If anything, a lower tax burden seems to be associated with a slightly lower average public debt. Debts are run up when governments borrow (and then spend) too much.

In a review of major studies between 1983 and 2012, Will McBride, former Tax Foundation chief, located 26 studies in total, out of which all but three, and all in the last 15 years, found a negative effect of taxes on growth.

There is no question that increasing the tax burden on the rich to, say 70%, will in the net result increase the aggregate tax burden of the US dramatically. The reason is that the rich already pay the lion’s share of taxes. For example, in 2016 the top 1 percent in the US paid a greater share of individual income taxes (37.3 percent) than the bottom 90 percent combined (30.5 percent).

Increasing the marginal tax rate to something like 70% is thus very likely to depress both tax takings and economic growth. That will mean less money for welfare, health and education, reductions in investments and employment and lower wages. Whilst those outcomes are designed to reduce the income of the rich, they are almost guaranteed to harm the middle class and the poor more.

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