The Rich Are Different Than You and Me

Michael Barone does a pretty fair job of explaining why anybody who thinks that we can right our fiscal ship of state solely by increasing the taxes on the incomes of “the rich” are sure to be disappointed:

That’s wrong as a matter of simple arithmetic, as is clear from a chart reproduced on the Wall Street Journal editorial page showing the total amounts of taxable income of each group.

The chart showed that if the government had simply confiscated every dollar from those reporting more than $1 million taxable income in 2008, it would not have gotten the $1.3 trillion needed to close the current federal budget deficit.

What the chart doesn’t show, however, is even more important. And that is that when you reduce income tax rates, high earners have more taxable income. When you raise them, they have less.

High earners don’t sit around waiting to have their money confiscated any more than chickens sit around and let you pluck out all their feathers. They pursue other options.

This is most obvious when you think about capital gains. The federal government doesn’t try to tax capital gains — the increase in values of your stocks or your house — every year (professor Bittker had us in knots explaining how it might do this). You pay capital gains on a stock or house only in the year you sell it.

What happens if the capital gains tax goes up from 15 percent to 50 percent? People stop selling stocks and hold on to their houses if they possibly can. And when cap gains rates go down? They’re more willing to sell, pay the lower tax and invest in something else.

That’s why the government’s total revenues from capital gains have tended to rise when the capital gains tax rate is lowered. And why increases in the capital gains tax rate never raises the amount of revenues static models estimate it will.

Don’t misconstrue my pointing to this as a belief on my part that I support extending the “Bush tax cuts” (I don’t care whether they’re the Bush tax cuts or the Obama tax rates), that I think the government doesn’t need to increase the revenue it produces, or that tax cuts always pay for themselves. As I have said repeatedly year I think it’s practically and politically necessary to balance the budget by a combination of increasing revenues and cutting expenses. The most likely source of increased revenue is from high income earners. Like Willie Sutton I know that you’ve got to go where the money is. And, similarly, cuts must come from where most of the money is being spent: Social Security, defense, and healthcare. The reason we’ve got to do these things however unpleasant or even disastrous we find them is to tamp down a fast-increasing non-discretionary spending item: interest on the debt.

I’m happy to provide my own answer to the question that Mr. Barone asks at the beginning of his column: income is what you report on your 1040.

However, the great debate on taxes is not what the rates should be but how you determine income. Taxing the income of the well-to-do, as suggested above, is risky. They can adjust their incomes in ways that those who depend mostly on W2 income can’t. By the way is there some straightforward way of determining total aggregate W2 wages year by year? I’ve looked and have found the numbers terribly difficult to come by.

If the class warriors were really serious, we’d be hearing more about taxing wealth (did you know that France has a wealth tax?) rather than taxing income. Funny how all those millionaires in both parties in the Senate never seem to raise the subject. If they did I’m sure the screams would be heard from here to Reykjavik.

24 comments… add one
  • Drew Link

    Heh. This is one of those ‘Dave pretty much knocks it out of the park’ essays.

    1. No, as a matter of simple arithmetic you can’t soak the rich and solve the problem. The glory in this is you don’t need to engage in an incentives debate. And even if you increased rates marginally – and had to discuss incentives and get tied in knots about it being “part of the mix” – you don’t even come close.

    2. Doug Maticonis, over at OTB, posted something recently that got me and jp going in circles. Some dishonest prof purported to show that taxes were at a 60 year low, by citing the tax to GDP ratio. The prof conveniently forgot to take into account the more relevant statistic: tax to income (which has doubled in his chosen time frame) and the concept of goosing GDP with debt financing, which is a balance sheet item, not an income or tax item. Point: the reality is that if you combine the current tax level and the increasing progressivity a certain Golden Goose is looking a bit ill. But, as Dave points out, that Goose is rich and resourceful, and will not stand by waiting for slaughter.

    3. As for taxing wealth, Dave had a brain cramp. Once you get there, the end is near. One of the earliest financings I did as a banker was a Danish company that had to be sold because of the wealth tax. The transaction was stupid, but tax driven. The owners soon left Denmark. Fast forward. My firm bought a S African company divestiture in 2006 for the very same reasons. S African companies were forced to divest companies because of idiotic notions like wealth taxes (and reparations). We stole the company. Made a fortune. The S African owners got hosed. S Africa is no better off.

    Like I said, once you are so desperate and incapable of dealing with your drunken sailor spending ways that you go there, you will see capital and citizen flight from the US. Count on it. And then the US as we know it is over.

  • As for taxing wealth, Dave had a brain cramp. Once you get there, the end is near.

    I wasn’t recommending a wealth tax, merely using it to show the name of the game. Income taxes reduce the accumulation of capital; they don’t prevent people from being rich but they do make it harder to get rich.

    Those who are already rich and powerful are as concerned with beating down the competition as they are with staying that way. That’s one of the reasons we have an income tax. The class warfare rhetoric is just to impress the yokels.

  • PD Shaw Link

    I think we do things that proximate wealth taxes, taxes on estates, taxes on real property (with differentiations between homestead and non-homestead). I’d be curious to hear how a wealth tax could be imposed in this country. Estate taxes aren’t really wealth taxes since they are really a tax on a transaction at a specific point in time, and you can put the burden on someone to value the estate as part of administration. Real estate is a big item, with is closely related to transactions in which valuation is important.

    Illinois may have had a wealth tax in Lincoln’s time; I seem to recall a postcard-sized return in which he claims to own essentially nothing before become President — his debts are about even with his assets. While I think that was essentially true, I recall thinking this was not a particularly reliable form of reporting wealth.

  • PD Shaw Link

    Oh yes, the old story I’ve heard touring historic houses throughout the country; the government taxed the number of rooms and closets were counted as rooms, so the well-to-do built houses without closets, they had big rooms and beautiful armouires that you could live-in.

  • sam Link

    I think Drew missed this part of the Dave’s piece:

    As I have said repeatedly year I think it’s practically and politically necessary to balance the budget by a combination of increasing revenues and cutting expenses. The most likely source of increased revenue is from high income earners. Like Willie Sutton I know that you’ve got to go where the money is.

    Da money is where you is, Drew.

  • Drew,

    Discussions about marginal tax rates (which are the primary discussions for most people it seems) aren’t very useful. We really need to look at effective tax rates and I think for the rich, those are at or near historic lows – somewhere around 17% IIRC. My own effective rate is about 4% which isn’t near my supposed top marginal rate of 25% and is also at an all-time low.

    Personally, I don’t think marginal rates need adjusting – it’s the rest of the tax code, the complexity and all the deductions that need some serious housecleaning.

  • Sam Link

    Personally, I don’t think marginal rates need adjusting – it’s the rest of the tax code, the complexity and all the deductions that need some serious housecleaning.

    In fact marginal rates could come down and still get more revenue if we’d just get rid of some stupid deductions. Unfortunately Grover N. has all the House Republicans in a stupid tax pledge and unable to vote for a rate lowering, deduction eliminating, efficiency increasing tax code if it happens to actually raise revenue.

  • Sam Link

    And it doesn’t help that one party finds it more important to shrink government (well, government revenue anyway) than to have an efficient tax code. In fact, an inefficient, annoying tax code is to their advantage and actively sought after.

  • steve Link

    ” Point: the reality is that if you combine the current tax level and the increasing progressivity”

    The top 400 pay 16.6% of income in taxes. Not that progressive. Drucker, at Businessweek, goes over how income is hidden. Most of these laws are clearly written for very few people. Ryan claims that we will lower the top rate to 25% and close loopholes. I foresee the top rate dropping but the loopholes remaining. The wealthy want them there.

    “That’s why the government’s total revenues from capital gains have tended to rise when the capital gains tax rate is lowered. And why increases in the capital gains tax rate never raises the amount of revenues static models estimate it will.”

    When you look at capital gains revenue, you see a one year effect with earning accelerated or delayed as needed, then things go back to normal with underlying economic conditions driving revenue.

    http://faculty.chicagobooth.edu/austan.goolsbee/research/laf.pdf

    Steve

  • sam Link

    I was gonna ask Drew what his effective tax rate was this go-around, but I thought, Gee, that’s kinda gauche. But then I thought, Well, hell, he’s always telling us how much money he’s made, or what his quarterly tax submissions are (in number of figures anyway), so, what the hey, Just what was your effective tax rate the go-around, Drew?

  • john personna Link

    Isn’t Barone’s piece an example of looking for one transformation from correlation to causation, and calling it a day?

    Of course the rich can decide when to book income, and that is a factor.

    They also have taxable income handed to them in less avoidable ways. In a big economic year there are big dividends. To avoid those you’d need to ditch stocks. Capital gains. Or in a hot IPO year, you’ve got to IPO. You don’t look at tax rate. Or in a year of high consumer spending, customers beat down their doors …

    But more importantly there is also the negative correlation that Barone might miss … when revenues are high, because economic conditions are high, government has no reason to raise and may even lower taxes.

    What happened there? Chicken or egg? Certainly some will claim that the lower taxes yielded the income and tax revenue, though it may have been the reverse.

    Overall, beware simplistic explanations that attempt to extract one big theme from 50 or 100 years of very different economic, social, and tax environments.

  • Drew Link

    sam –

    “Da money is where you is, Drew.” Yes, but it doesn’t follow that it should be taxed away.

    “But then I thought, Well, hell, he’s always telling us how much money he’s made, or what his quarterly tax submissions are (in number of figures anyway), so, what the hey,”

    Implicit – or perhaps explicitly – in your question is the notion of braggadocio. If I’ve given that impression I apologize. And I mean that sincerely. If you actually knew me you would know I’m just the opposite. I talk about money and income so matter of factly for two reasons: 1) because I in no way define people by income (I know an awful lot of rich people who are similar to something you might scrape off your shoes after people have taken their dogs for the morning walk) and 2) so much of the discussion here and at OTB revolves around economics, tax policy etc and because of my business I know first hand how people with high incomes or wealth react – and I weigh in accordingly because I see so much misguided commentary.

    As for the specifics of your question, you actually already know the answer. In any given year someone (yes, like me) with high ordinary income will approach the marginal tax rate, by definition. In years with a high proportion of cap gains of course the rate declines. But this is a perfect example of what I mean. People act as if income on capital is ill gotten. They forget that the original income that producced the capital base has already been taxed, probably at a high rate, and that capital formation is a good thing. Its an indicator of envy, not sound tax policy thinking.

  • Drew Link

    I often hear people commenting about “hiding” income. I only know of a handful of examples where that works, and its usually for the super-duper rich and involves things like Cayman Island organizations.

    Timing of income is a far different thing. Last year, before it was clear that the tax rates would not change, there was so much M&A activity that it actually placed a strain on the availability of the 3rd party professions (lawyers, accts. inv bankers). Anyone who doesn’t think people react in a very real way to the tax code is nuts. It was fascinating. As soon as the cap gains rate was no longer in jeopardy people who didn’t have to sell pulled their companies off the market and didn’t, and the bottom fell out of the M&A market.

    I really have to wonder what would have happened to the public equity markets had the rates changed. DOW 8000? Think about that.

  • Drew Link

    Missed this earlier.

    “I wasn’t recommending a wealth tax, merely using it to show the name of the game.”

    Got it.

    “Those who are already rich and powerful are as concerned with beating down the competition as they are with staying that way.”

    Perhaps some. But we have a word to describe them: “assholes.”
    I certainly think anyone who espouses the general philosophies that I do desires just the opposite – that anyone willing to do the work and take the risks can reap the financial benefits, and not let those who are not willing – always in the name of some sympathetic group – vote for a system where it is taken away.

  • As I’ve said before I spent the first half of my childhood literally surrounded by drug dealers, numbers runners, hookers, and thugs and the second half just as literally surrounded by Schlaflys, Symingtons, Busches, and Danforths. Dave Lichtenstein, founder of Liberty Loans, at one time a huge nationwide finance company, had grown up in the same neighborhood as my dad and lived right in back of us.

    Most of the guys who went to my high school were kids from blue collar families or modest white collar families but some were from the richest families in St. Louis. Entrance was by competitive examination and the Jebbies didn’t make exceptions. They were no respecters of personages.

    It’s given me a rather, shall we say, distinctive perspective. One of the things I learned was that the really rich might be just as tough as the poor and could also be less honest.

    BTW, when I say “rich” I mean the really rich. I wouldn’t characterize either Drew or President Obama as rich, just well-to-do.

  • sam Link

    “that anyone willing to do the work and take the risks can reap the financial benefits, and not let those who are not willing – always in the name of some sympathetic group – vote for a system where it is taken away.”

    I hope that doesn’t mean that you’d restrict the franchise to those “do the work and take the risks”, i.e., people like you.

  • Drew Link

    “BTW, when I say “rich” I mean the really rich. I wouldn’t characterize either Drew or President Obama as rich, just well-to-do.”

    I’ll reverse the order here. That’s absolutely correct. Its politically convenient for some to characterize me as “rich,” – simply because they want to raid my bank account – but I am in fact not “rich,” don’t consider myself “rich,” don’t economically behave as if I’m “rich” and in point of fact don’t want to do what it would take to become “rich.” Because that’s a bitch. Heh. I’ve found my calling: Poetry.

    Dave’s right, I’m “well off,” and I, like so many others, worked damned hard to get here. And that’s OK. I just don’t want Johnny Come Lately to lay claim to my wealth for their own benefit and on spurious theories that it was ill gotten or that somehow I owe society. I have very definite ideas on how to spend my wealth. And I want it on my terms and on the merits I deem appropriate, not Barack Obama’s ridiculous giveaways. And most of my focus is on education and entrepreneurship. Anyone surprised??

    “It’s given me a rather, shall we say, distinctive perspective. One of the things I learned was that the really rich might be just as tough as the poor and could also be less honest.”

    I don’t see honesty as a function of money, but I do understand your point. Dogs were walked this morning………

    But this has formed an opinion or philosophy of mine that few people seem to accept: if you are correct, Dave, who is most capable of using government to their own ends? And why do we give them the opportunity? The rich controlling government for subsidy is a travesty. (See GE, and Immelts current unholy alliance.) Conversely, the poor voting the treasury to them is a travesty. Or better: lying, bastard politicians like Obama appealing to the poor to that end for votes. Better to limit government’s power. No?

  • Drew Link

    “I hope that doesn’t mean that you’d restrict the franchise to those “do the work and take the risks”, i.e., people like you.”

    A weak response. What’s “the franchise?”

  • Steve, worth noting, that’s 400 families. If by “the rich” that’s what we mean, then that’s a problem. However, if you look at the top 1%, they’re paying more than anyone else in federal taxes. Maybe not as much more as they should (depending on your perspective), but more.

    I make this distinction because I wouldn’t want taxes raised on someone making $500m a year raised by another 10% just to force those rat-bastard 400 households to pay another 2 or 3 (given their relative immunity from their tax bracket, I suspect their rate increase would be less).

  • What’s “the franchise?”

    I’m pretty sure he’s referring to the right to vote.

  • The top 400 pay 16.6% of income in taxes. Not that progressive. Drucker, at Businessweek, goes over how income is hidden. Most of these laws are clearly written for very few people. Ryan claims that we will lower the top rate to 25% and close loopholes. I foresee the top rate dropping but the loopholes remaining. The wealthy want them there.

    Everything comes with trade offs even using tax loop holes. Reduce the rate you reduce the incentive to use the loop holes.

    Further, I’d call your attention to this part of your comment:

    Most of these laws are clearly written for very few people.

    That is the real problem. That the rich and super-rich can pretty much dictate policy. Making the tax code extremely simple with no loop holes is the ideal. Once you start fooling around with this credit, that subsidy, that special rate and so forth you create loop holes, complications and so forth.

    Of course, this is why tax proposals like Hall and Rabushka’s proposal will never go anywhere. It is progressive, simple, and would increase overall economic efficiency. The down side is that people who Larry Summers hob-nobs with wont get all their special considerations and thus hate it.

  • Mercer Link

    Chait attacks a WSJ editorial. I think it is the same one Barone is referencing.

    http://www.tnr.com/blog/jonathan-chait/87197/wsj-edit-page-disproves-own-point

  • PD Shaw Link

    Looking into the French wealth tax, I found this background:

    “It is for each household to assess and determine for themselves whether or not they consider they are liable to pay wealth tax. There is no need for a professional valuation to be made.

    To some extent, therefore, there is an element of voluntarism in the declaration of tax liability!

    However, in the event that the tax authorities decide that you are liable to pay wealth tax, they are entitled to collect arrears of payment over the proceeding 10 years.

    The French tax authority does have sight of all property transactions in the country so will be aware of the price you paid for a property.”

    http://www.french-property.com/guides/france/finance-taxation/taxation/wealth-tax/

    A number of things about this, the notion of volunteerism, perchance dissimilar treatment, and ultimately what is likely heavy reliance on real property.

  • Restell Link

    The wealth tax in France is somewhat of an anomaly; most European countries have abandoned theirs. The current (conservative) government campaigned on getting rid of it, but since the 2008 crisis “soak the rich” rhetoric in France has gotten even worse than usual. I think they may have scrapped that plan.

    In any case, as is often true, it hurts the next-to-richest more than the richest. French sports stars, actors, and big businessmen just set up residence in surrounding countries, they’re a 3-hour train ride away.

    The moderately well-off fellow who just inherited a 300-year-old country house from his deceased parents? Soaked.

    I still think it’s going to go the way of the dodo sooner rather than later.

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