The Tax Rate Racket

The Tax Rate Racket
By Bill Murchison
11/16/2010

The flap over whether to extend present tax rates for the rich finds its center in a cultural proposition: Liberals, including rich liberals, either don't like the rich or feel obliged to pretend they don't.

The argument official Washington will have this month over tax rates -- Republicans on one side, President Obama on the other side -- is perhaps the oldest argument in politics. They had it 2,500 years ago in Rome: plebes vs. patricians. They'll have it 2,500 years from now (assuming no Second Coming of Christ disarranges worldly affairs). At least the language will be familiar: fat cats, plutocrats, the middle class, the poor, compassion, justice, fairness, highway robbery, grrrrrrrrr.

Nothing ever changes in this dreary context: which is why whatever Congress decides to do during the lame duck session about extension of the rate reductions voted in 2001 will decide nothing in the end, there being no end to the dislike of those who have more. Such is human nature.

Alas, because endless ranting over "income distribution" policies diverts attention from the more useful goals of maximizing opportunity and promoting growth for all, if at the unequal pace that nature and luck have decreed. You'll figure this out by watching the wrangling in Washington, D.C., this month.

Iago counseled Othello, "O! beware, my lord, of jealousy; It is the green-eyed monster ... " -- an apt image for modern times, in that we talk of dollar bills as "green." The really monstrous part of the equation is the blindness it induces. The wealthy pay most of our taxes right now. Can't we see that?

The Tax Foundation, which exercises impartial oversight over the numbers, says the top 5 percent of taxpayers in 2008 (adjusted gross income, $156,619) earned 34.7 percent of AGI while paying 58.7 percent of federal individual income taxes. The top 1 percent paid 38.02 percent of all taxes, whereas the bottom 1 percent (adjusted gross income of $33,408) paid 2.70 percent. Without those rich people paying taxes, where would we be? Ask around in California, whose economy -- heavily dependent on revenues from the fat cats of Silicon Valley and like venues -- is underwater in large measure due to the recession's effects on those same fat cats.

Taxes on income, first levied in Britain in 1895 and in the United States after 1913, have a patina of fairness and equity. Why shouldn't those with the most pay the most? They can afford to. Warren Buffett often make this point. As we see, even so, they pay more already. Equally to the point, as Congress commences debate on extending the 2001 rates, tax hikes don't always bring in the revenues their proponents project. This is because changes in tax rates cause changes in behavior.

As Milton Friedman was wont to say, in propounding an important rule of thumb, if you want more of something (e.g., work, investment), you reward it (e.g., cut taxes); if you want less of it, you penalize it. You raise the cost. You make harder, more creative, more imaginative work less pleasant by grabbing more of the reward that comes from success at it. As you do so, you unnecessarily depress revenues. The more you grab, the less you get.

That's to speak broadly, of course. Life can't be reduced to an equation. It remains a safe bet all the same that incentives outrank penalties when it comes to policies that bear on job creation and economic expansion.

Extension of all, not just some, of the tax rates isn't the Platonic solution for our current economic woes. It better fits the present case than does presidential desire to grind the faces of the rich, mostly to please Democratic constituents who get a kick out of such spectacles -- and often reward those who stage them.

See how this tax rate game stirs both sides to activity? Liberals troll for votes. Proponents of economic freedom seek job growth, opportunity and the creation of things that never before existed. On which basis was America made? Guess.