June 09, 2008

Obama's plan to tax the rich won't work

Businessweek discusses Obama's plan to increase the marginal tax rate back to the level under Bill Clinton and before the Bush tax cuts

Of the 149 million households filing federal income taxes for 2006, some 3% reported income between $200,000 and $500,000; fewer than 1% claimed income above half a million dollars.

The Bush administration instituted a federal tax cut for all taxpayers. Among other changes, the lowest income tax rate was lowered from 15% to 10%, the 27% rate went to 25%, the 30% rate went to 28%, the 35% rate went to 33%, and the top marginal tax rate went from 39.6% to 35%

Many people believe that increasing the marginal rate will collect more revenue from the the rich or for the government in general. Historically it does not matter if the top marginal rate is 90% or 25% the government collects 19.5% of GDP. The only way to get more tax revenue is to increase GDP. Such as a concerted effort to accelerate a manufacturing and construction revolution using new systems and technology.

Economists of all persuasions accept that a tax rate hike will reduce GDP, in which case Hauser's Law says it will also lower tax revenue. That's a highly inconvenient truth for redistributive tax policy, and it flies in the face of deeply felt beliefs about social justice. It would surely be unpopular today with those presidential candidates who plan to raise tax rates on the rich – if they knew about it.

Although Hauser's Law sounds like a restatement of the Laffer Curve (and Mr. Hauser did cite Arthur Laffer in his original article), it has independent validity. Because Mr. Laffer's curve is a theoretical insight, theoreticians find it easy to quibble with. Test cases, where the economy responds to a tax change, always lend themselves to many alternative explanations. Conventional economists, despite immense publicity, have yet to swallow the Laffer Curve. When it is mentioned at all by critics, it is often as an object of scorn.

Because Mr. Hauser's horizontal straight line is a simple fact, it is ultimately far more compelling. It also presents a major opportunity. It seems likely that the tax system could maintain a 19.5% yield with a top bracket even lower than 35%.

The fact that no matter what the rates and brackets all that can be obtained is 19.5% that argues for as simple a tax code as possible for getting that 19.5%.

The fair tax
or a
Relatively flat tax

The wealthier someone is then the more control they can have over their financial profile. Money can be shifted between income, corporate profits, dividends and capital gains and new income can be shifted between jurisdictions.


Tax brackets 1971-1978

1975 Median income 11,800 Mean income 13,779
Someone making 5 times the median income. Would be in the 60k-70k range.
(equal to someone now making 200,000).
Tax rate would be 53-55%.

1965 Median income was $6900 Five times that was 35,000 for 50-53% tax rate.

CBO analysis of long term taxes

Heritage examination of taxes

Comparing some tax burdens between countries

Comparing top marginal individual and corporate tax rates

Historical lessons of lower tax rates


John said...

Good analysis, but Obama isn't interested in higher tax revenues and doesn't care if his plan works or not.

All he is interested in is a tax plan that he deems "fair." He believes the "rich" should pay higher taxes because he feels that is "fair." This is what he has been saying on the campaign trail.

Brian Hayes said...

It seems the argument says that progressive tax rates including the rich have a minor effect because the wealthy are a minor percentage. "3% reported income between $200,000 and $500,000; fewer than 1% claimed income above half a million dollars."

But this impression clouds the tremendous holdings of this small factor. One percent or less owns 49% or more of the whole and entire planet!

One, we know too little about these rich. Two, we know too little to settle. Three, the bottom is the challenge, the duty, and the path to both our sustenance and prosperity.

We've been suckered, I'm saying, at least a generation and maybe forever.

In my view, no argument about taxation is valid if relief is an option but obligation is the task.

Daniell said...

Two things:

1) The percentage tax levied on the highest earners is only a very small part of the total tax picture. The income bracket at which that rate kicks in, used to be $400K when it was 90%, in 1988 and 1989 it was $88K when it was 28%. That's a big difference in who's paying that 19.5% to the government.

2) And about that 19.5% percent. The revenue and income tax revenues are all squashed down because of the high numbers in the percentage lines. This hides the fact that income tax revenues decreased when the Bush tax cuts took effect. If you look carefully, though, you can still see that there's a lot of activity in those two lines, but you can't see it at the vertical scale chosen in this graph.

3) Economists accept the Laffer curve, they just think it doesn't apply when the overall tax rate is as low as it is in the US. For total taxes rates below 40%, cutting taxes, cuts revenue, period.

The graphics in this post are dishonest and the arguments are misleading. They are the economic equivalent of a physicist trying to convince you he has a perpetual motion machine.

Sven Ortmann said...

The tax rate is just one variable, exceptions and other rules are very important as well.

The Laffer curve doesn't mean tax cuts = more tax revenue, that works only if the tax rate is too high, beyond the optimum.
The U.S. is likely already short of the optimum due to past cuts.

bw said...

Added in details on tax brackets for the sixties and seventies and correlated to median income and multiples of median income for 200k-250k equivalent of today.

The point is that even when income tax rates for tax brackets are higher it triggers tax avoidance strategies.

Just as many tax strategies today revolve around AMT avoidance.

The current international rates are shown so that it can be seen that wealthier people have lower tax rate jurisdiction options. If one is wealthier it is far easier to change citizenship and tax home.

Increasing the tax rate on the rich for "fairness" or for tax revenues will not work to get more money so tax revenues do not increase and "fairness" is not increased if no more money is obtained.

The holdings (net worth) of the already wealthy is mostly not touched because there is no tax if assets are not sold. There has to be taxable events.