Tax Rates

Higher tax rates on the wealthy will reduce economic growth. The literature on taxing the rich and economic growth is quite weak. There are studies purporting to look at this question, but they are often little more than looking at a historical correlation between tax rates and growth, which is simply not a very sound research method as it ignores other factors that have larger impacts on growth among other reasons. First, we have evidence that higher tax rates in general have a negative impact on growth. An overview of this literature is available the sources. The Tax Foundation chronicles these sources [1]. We also have evidence that higher tax rates are responsible for the relative decline in hours worked in Europe relative to the USA, which has contributed to Europe being less productive [2]. Second, we have the evidence that more progressive tax rates harm economic growth. An example of some of this evidence is in the sources [3]. Finally, we have the evidence on how the behavior of rich people changes when taxes are changed. The evidence suggests that the behavioral responses are significant [4]. Taken as a whole, the evidence suggests that higher tax rates reduce economic growth in general, more progressive tax rates reduce economic growth, and rich individuals have quite large behavioral responses to changes in taxation. This is important as the main channels through which high tax rates harm economic growth are on the supply side rather than the demand side. Entrepreneurship is one of the central drivers of economic growth [5]. After all, entrepreneurs are necessary to continually innovate in a constantly changing economy. Unfortunately, highly progressive taxation decreases entrepreneurship. This is simple to imagine if one looks at two men who both have a job that pays $200,000 and a potentially good idea. Both men pay 20% tax rates on their $200,000 income and, if they are to pursue their idea, they would be forced to give up their job. The difference is that one man lives in a country with a flat tax regime of 20%. The other man lives in a supposedly "fairer" society where the first $200,000 are taxed at 20% but every dollar after that is taxed at a punitive 80%. This would dramatically lower the chances that this man would become an entrepreneur. This is a rather extreme example, but the logic applies to any progressive tax regime to varying degrees. Not surprisingly, there is strong evidence that progressive taxation has a negative effect on entrepreneurship [6]. High tax rates discourage productive behavior such as investing, working, and taking risks and encourages unproductive behavior such as tax avoidance. The evidence provided in the sources suggests that this effect is quite powerful and makes a meaningful difference in the economy. It's also important to note that wealthy individuals are more able to change the composition of their income so they can more easily avoid taxes, which is why they have such high elasticities of taxable income [4]. There is a widespread belief that taxes on the richest 1% are low. This is simply not the case. It seems that this perception is based entirely on anecdotal evidence. There is no doubt that some rich people pay low tax rates, but, as a whole, the richest 1% pay quite high taxes. The CBO estimates that, in 2013, the top 1% paid an average federal tax rate of 33.6%, compared to 18.1% average for all quintiles [7]. This does not include state and local taxes which, according to reasonable estimates, add another 6% or so to the average tax bill of the top 1% [8]. In total, this suggests a tax rate of around 40% on average, with some higher and some lower. I find it very hard to argue that one's "fair share" is more than 40%. Admittedly, this is a bit subjective because everyone has a different belief system about what is fair, but I think the fact that wealthy individuals already pay almost 35% of their income to the federal government and 40% to all governments would come off to most reasonable people as, if anything, too high, especially when realizes that the wealthy are already paying a higher tax rate than other classes. The practical problems with raising taxes on the rich have already been discussed, at length here. I also believe there is a moral element to this debate. Do we really want to live in a society where nearly half (or over half) of somebody's income is confiscated by the government? I certainly don't. America was founded as a free nation, with free enterprise at its core. One of the key tenets of free enterprise is that the government sets no limit on wealth. It is understood that taxes are necessary to pay for basic services and such, but I think it is hard to say that people paying 40% of their income in taxes are not paying their "fair share". No, raising taxes on the wealthy, at this point, would bring us to a place with tax rates that are better described as "confiscatory" than "fair". Confiscatory tax rates on any class or group is totally contrary to the moral core of the USA. Raising taxes further on the wealthy would be a moral and practical mistake. 1. http://taxfoundation.org... 2. http://www.economics21.org... 3. http://business.pages.tcnj.edu... 4. http://www.economics21.org... 5. http://www.nber.org... 6. http://www2.gsb.columbia.edu... 7. http://www.cbo.gov... 8. http://www.itep.org...