James Kwak | Five Arguments Against Tax “Increases“

Last week, a professor making more than $250,000 per year (with his wife’s income) put up a blog post (since taken down) criticizing President Obama for wanting to “raise” his taxes.* The post basically said, after all of their basic expenses, “we are just getting by despite seeming to be rich.” If his taxes go up, he says he will have to cut back on spending, which will depress the economy, or perhaps even sell his house or cars, which will depress those asset markets. The problem, he argues, is that the tax “increases” won’t affect the true super-rich, because they use tax dodges to avoid paying taxes; instead, they will just hurt the economy.

This post has been the target of some howitzers on the Internet, mainly focused on the professor’s income and expenses, but I wanted to raise a few more general policy points.

First, it’s just not true that the rich will reduce their spending dollar-for-dollar as their taxes go up. The reason that tax cuts are a lousy form of stimulus applies in reverse: just as extra cash leads to more saving, less cash leads to less saving. And this is especially true for the rich, who have more slack in their budgets. There might be individual rich households that will reduce their spending dollar-for-dollar, but in aggregate it just won’t happen.

Second, there certainly are hard-working, young, dual-income, multiple-child, productive families who have high expenses. It is true that there is no single thing as “the rich.” Different people making $250,000 consume different amounts, and it’s not just a function of personal virtue; it’s also a function of where you live (some of those high salaries come in places with high costs of living) and where you are in your career lifecycle. But the obvious implication of that banal observation is that we should tax wealth, not income, or wealth in addition to income. If the people arguing against “raising” taxes on the rich were arguing for a wealth tax, or at least for a meaningful estate tax, then I would have more sympathy for them. (Or, say, a consumption tax with an exclusion for the first $40,000 of consumption.)**

Third, the “Cayman Islands” argument (that the really rich don’t pay taxes) is mainly false and, to the extent it is true, again yields a different policy conclusion. Warren Buffett, for example, pays an average tax rate of 18%, so the claim that “the super rich don’t pay taxes” is just not true. Now, that is a lower tax rate than many middle-class households, but the reasons for that are well known. Again, we tax income, not wealth; we tax capital gains and dividends at much lower rates than salary (again, thanks to George W. Bush), and the rich get a larger proportion of their income from investments; and the taxes that affect most working people are actually regressive, because of the cap on the payroll tax. So I would have more sympathy for the Cayman Islands argument if its author were also arguing for lifting the cap on the payroll tax and eliminating the tax breaks for capital gains and dividends.

Fourth, if it is true that the rich are feeling squeezed, this actually undermines the main argument against tax “increases”–that higher marginal rates will cause people to work less hard. If households making over $250,000 per year really have no fat in their budgets, then “raising” marginal tax rates will not affect their propensity to work, which is what you want from an economic standpoint.

Fifth, the professor makes the tired old argument that his spending (which goes to local “entrepreneurs”) is better than government spending (“handouts”). In general, I agree that it is better to make our production decisions based on consumers’ preferences rather than congressional votes. But the entrepreneurs-vs.-handouts is a red herring. In the long term, the choice is between consumption by the rich and health care for the elderly (Medicare). You can call this redistribution.*** But given that old people generally need more health care than young people, given that old people generally make less money than young people, and given that health care costs continue to grow faster than inflation, the question is whether we’re willing to let people suffer in their old age simply because they couldn’t save enough money in their lifetimes to pay for their medical emergencies in retirement. (And there will also be people who make lots of money, save lots of it, and still go broke in old age because they lose the medical lottery.) There are people who are willing to come out and say that. But most people opposing tax “increases” are not. Instead, they prefer to malign government spending in general.

In the long term, we have a big fiscal problem. Yes, “raising” taxes will have some impact on the economy. But we have to do something. Since partisan gridlock rules out any significant reform of the tax system (and even rules out sensible compromises like delaying the tax “increases” until the economy recovers), the only available lever to increase government revenue is letting Bush tax cuts expire. It’s a blunt tool, but in the current political climate it’s the only one we’ve got.

* Of course, as we all know, it’s President Bush who is raising his taxes; what’s happening is the Bush tax cuts had sunset provisions so that they could make the true fiscal costs of the tax cuts seem artificially small, and those sunset provisions are about to kick in.

** The other implication is that if you’re young and have a high salary but high expenses, you should just borrow more money; you’re really just borrowing from your future self, because someday the house will be paid off, the kids will be done with college, and you’ll be making even more money since you’ll have more seniority and experience.

*** Most people think that a progressive tax system is redistributive. I’m not sure. The issue is who you think benefits more from government spending–the rich or the poor. The conventional answer is that the poor do, because they get “handouts.” But imagine a world without government. Who would lose more? Assuredly the rich, who would no longer have the armed forces, the police, and the courts (and the FDIC) to protect their property. I guess you could have a private security market, but how could you maintain, say, a financial system where most of your wealth is bits on a computer somewhere without a government to back it up?