Bohanon: Now to Tax You ‘Rich’ With Minimal Hissing

November 26, 2012

by Cecil Bohanon, Ph.D. 

The 17-century French finance minister Jean-Baptiste Colbert is reported to have said “the art of taxation is plucking the feathers from the goose with as little hissing as possible.” With this in mind consider a “rich” taxpayer that we’d like to pluck “just a little bit more.”

Let’s set up a shill — Linda Bleedingheart a narcissistic popular folksinger who commands $100K for each of her five standing-room-only concerts for an annual income of $500K. Whether we like to admit it or not, an additional concert from Linda enhances the economy: It inevitably employs others and gives consumers more of what they want.

Let’s suppose Linda takes $100K in deductions (for the mortgage interest she pays on her gosh over-sized Mansion), and suppose a simple tax structure where the first $200K of taxable income is subject to a 10-percent rate and anything above that is subject to a 30-percent rate. Linda currently pays $80K in taxes ($200K*.10 + $200k*.30 = $80K).

Now note something interesting. If we assume no change in Linda’s behavior — a dubious but usual assumption in these kinds of exercises — we can get and additional $6K by limiting her deductions to $80K. Twenty-thousand dollars in lost deductions  taxed at 30 percent yields $6K. Alternatively we could raise an additional $6K by raising the second-tier tax rate to 33 percent while leaving her deductions unaffected. In this case the $200K subject to the additional three-percent tax yields $6K.

Although in either case the additional revenue yield is the same, there is a big difference between the two approaches. If Linda is offered an additional $100K gig, the net additional or marginal benefit to her is $70K under the current structure — and it remains $70K under the limit-deductions tax hike. The net marginal benefit, however, falls to $66.6K under the pluck-the-goose approach. Increased marginal tax rates generate a disincentive for income earning that limiting tax preferences do not. This is a point that economists of all political persuasions and stripes agree on and a center point of the Simpson-Bowles commission.

So why are certain progressive Democrats so adamant about raising tax rates on the rich as compared with just getting more tax revenue from them by limiting their deductions? It makes no sense except for two possible explanations.

First they may just want the money — sock-it-to-the rich by both reducing their deductions and raising their rates.  And then, I guess, raise their tax rates some more. But surely anyone recognizes that the assumption of “no behavior change” becomes less plausible as the proposed tax take from the rich rises. Despite progressives’ illusions, the rich are not an endless well that can fund all our special interest spending fantasies.

Second and more perverse, it seems that some progressives like the idea of high marginal tax rates precisely because they discourage high earners from engaging in additional income earning activity. To heck with the fact that an extra concert by Linda inevitably provides benefits to others — we can’t tolerate her getting any additional income. Promote income equality by destroying wealth — indulge in the sin of envy through the tax code.

Our current federal deficit is around $1 trillion. According to the current administration’s own estimates restoring the pre-Bush tax rates on the “rich” will yield around $35 billion in additional revenue. If a whole sock-it-to-the rich gamut is enacted it will yield around $110-$122 billion. This is peanuts, not to mention rosy estimates. In the absence of serious spending reductions and entitlement cutbacks, the deficit and debt crisis can only be solved by significantly increasing middle-class taxes. It is too bad this was not clearly articulated before the last election.

Cecil Bohanon, Ph.D., an adjunct scholar of the Indiana Policy Review Foundation, is a professor or economics at Ball State University.


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