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Should We Soak the Rich Into Oblivion?

In 1971 the band Ten Years After released their only hit, I’d Love to Change the World. The song was a protest of the Vietnam War, but also a lament on all the ills that had befallen society. 

Many took exception to the lyrics:

Tax the rich, feed the poor

‘Til there are no rich no more?

As we head into another presidential election season here in the states we are hearing more about taxes. While rhetoric about taxing the rich more is fun, it misses the point. Tax rates don’t cause social ills.

I don’t know anyone against feeding the poor. People of faith and of high ethical and moral fiber consider it a duty to help those in need. Feeding the hungry is good policy.

But will taxing the rich into oblivion actual end hunger? History says no! 

Bernie Sanders (I promise this is not a political post) has gone on the record as saying a wealth tax should be instituted until there are no more billionaires. Now I think Bernie Sanders is a heck of a nice guy and I like him, but he is wrong on this. By a natural extension, if the very rich should be extinct, should not rich nations be similarly penalized until there are no more rich nations? We’ve tried that before. It’s called communism and it did not work!

The refrain of our song in question continues:

I’d love to change the world

But I don’t know what to do

So I leave it up to you.

I accept that challenge. 

In this article we will discuss what the correct level of tax is to maximize government revenue without harming the economy, cutting government spending and the wealth tax proposed by several presidential candidates.

 

Laffer Curve

The Laffer Curve estimating maximum government revenue at 70% , as estimated by Trabant and Uhlig in 2017.

The Laffer Curve is named after Arthur Laffer who popularized the idea that levels of taxation and government revenues are interconnected. The idea is that anytime tax rates deviate from this optimal level government revenues will be negatively affected.

The top tax bracket has been declining in the U.S. since the early 1980s based upon the promise from the Laffer curve. 

The Laffer Curve is simple to graph and explain. It makes sense. If you lower taxes the spur to economic growth can actually increase government revenue. It’s almost like people advocating tax cuts want the government to collect more taxes! 

Another easy to understand part is when taxes are at the extremes. A tax rate of 0% obviously raised no revenue for the government. The is true of a 100% tax rate. After the first year there is nothing left to tax.

In the early 1920s the top tax bracket stood at 73% in the U.S. Then Secretary of the Treasury Andrew Mellon made the argument the high tax rates were harming economic growth and that lowering tax rates could actually increase government revenue. It wasn’t call the Laffer Curve back then (Art Laffer was still in the future). But the theory was the same.

Art Laffer has been discredited recently with alarming failures of his principle. He pushed states to lower taxes under the guise it would actually increase government receipts. Instead the state governments ran massive budget deficits and had to cut critical services, gut education and layoff teachers and increase taxes.

The Tax Cuts and Jobs Act of 2017 offered the same promise. A massive tax cut was passed by Congress and signed by the president. But government receipts barely moved. As spending increased the budget deficit exploded and now hovers around $1 trillion per year while the economic expansion is now at record length. Should there be a national crisis there could be problems. Funding a recovery from a natural disaster or military event will be more difficult if even possible, not to speak of necessary government stimulus needed during an economic slowdown.

Top historical tax bracket in the U.S. Source: https://bradfordtaxinstitute.com/Free_Resources/Federal-Income-Tax-Rates.aspx

 

The Right Level of Tax

Nobody wants to hear they need to pay higher taxes. I certainly enjoy a lower tax rate and work hard to help my clients pay the least tax possible legally. 

However, there is a problem. Lowering taxes no longer increases government revenue. Corporate tax revenue declined nearly a third  after the Tax Cuts and Jobs Act of 2017. 

I disagree with Mathias Trabandt and Harald Uhlig (see graph above). A 70% top income tax rate seems excessive to this old accountant’s eyes. 

Source: https://www.cbo.gov/about/products/budget-economic-data#2

As you can see from the above chart, personal income taxes receipts grew at about the nominal rate of GDP growth. Corporate taxes declined massively.

Some would argue corporate taxes are paid by people anyway so the lower rates helps everyone. But that begs two questions.

First, shouldn’t tax cuts increase government revenue as promised by the Laffer Curve? Individual tax collections increased about the same amount as corporate collections decreased. So the expected increase in revenue didn’t materialize and the added government spending blew a hole in the budget.

Second, if corporations are “persons” in the eyes of the law, as we are told every time a corporation want to make a political contribution, shouldn’t they be taxed as like every other person? Asking for a friend.

The truth is we have focused too much on the Laffer Curve. Most people never pay taxes at the highest rate. The level of taxes everyone else pays also plays a role. The top bracket also contains at least two lies. Taxpayers with earned income are slapped with an additional payroll tax (Social Security and Medicare tax, aka FICA or self-employment tax). Wages up to $132,900 in 2019 are hit with a 6.2% tax (double that for the self-employed) for Social Security. Medicare adds another 1.45% (double again to the self employed) on all wages and self-employment income. (Additional Medicare taxes can also apply in some instances for higher incomers.)

The point here is lower taxes will not solve the government’s budget problems. We need to cut spending if we are ever to gain sanity in Washington.

I don’t know the exact “right” level of tax. The “right” level is not always the level we should tax people at either. Milking taxpayers for maximum tax payments seems a bit obtuse to me. Less tax creates the opportunity for more wealth. That is good for any nation in the long run. In the short run, too.

 

Cutting Government Spending

Whenever I make a suggestion on government tax policy I always get a comment (many comments actually) about cutting government spending. This is where I’m glad I can sit in my easy chair and a mutter endlessly, “Lower Taxes. Lower Taxes. Lower taxes.”

Fixing government spending is easy to say and near impossible to accomplish. Social Security, Medicare, the military and interest on the debt consume virtually all federal government receipts! If we cut everything else to zero we still have a problem. 

The 2018 federal budget: outlays and revenues Source: https://www.cbo.gov/system/files/2019-06/55342-2018-budget.pdf

When the government has $1.4 trillion in discretionary spending and a $1 trillion budget deficit you need to cut more than just a bit of fat; you need a cleaver to sever arms and legs of government spending. Thank God I’m not an elected official who really has to figure this out before it is too late. 

Do we cut one of the Big 4?

We could cut Social Security and Medicare, but the government also collects a load of tax revenue from this source so this one is a non-starter unless you think we should keep collecting the tax while refusing to pay the benefits. Some fat can be trimmed here, but the pickings are slim. Not enough to make a large dent in the budget deficit.

We could default on the debt to save interest, but good luck ever borrowing money again at a reasonable rate. The next recession or military conflict we would be on our own.

And talking about the military. . .  Maybe a bit could be trimmed from national defense. There might be real savings if the military cut waste. But that is an ongoing battle that is never won. We need a strong military so meaningful cuts here will be difficult.

What remain are the discretionary items. So what do we cut here. We only need $1 trillion of reductions.

How about the TSA? Transportation? Agriculture? Maybe we can reduce infrastructure. The roads are pretty good. Right? 

If you are like me you can find waste to cut. Also like me, I bet you struggle with finding $1 trillion in cuts.

So if we are ever to balance the federal budget we are back to taxes; our favorite hated topic.

 

Wealth Tax

And this is where we came in. Bernie Sanders wants to tax the rich ’til there are no rich no more. Elizabeth Warren also advocates a wealth tax, albeit a smaller rate.

If we can’t tax income anymore then a wealth tax might be a reasonable suggestion. Sanders wants an 8% annual wealth tax. I feel the acid rising in my throat every time I hear this.

Warren has a smaller wealth tax. She also has a “Medicare for All” plan. In a few weeks I’ll be discussing a workable “Medicare for All” plan that actually cuts taxes while covering everyone if that is what people want. Stay tuned. You will like my solution to America’s health crisis. 

In either case a wealth tax is levied on the wealthy (not income, but actual wealth/net worth). I do have a problem with the wealth tax, however. 

Let’s use The Sanders plan because it illustrates the negative consequences easier. An 8% wealth tax would be paid by those with say $50 million or more in net worth. You can go to a billion net worth if you want; the problem is the same.

The assumption of a wealth tax is that rich people only do stupid or irritating stuff with their money and don’t deserve it.  I mean, thing about it. Elon Musk is building new businesses and technologies with his billions. How rude. Those created jobs are not worth it if we as a society must look at a billionaire like Musk.

Yes, I’m being facetious. That is the point. How can Musk create the technologies of tomorrow that will benefit the nation and environment, create jobs, and provide better products without the resources to do so? I don’t know if anyone has noticed, but it takes serious cash to start an electric car company, solar company and a space travel company. Without the super rich these dreams would go unfilled along with all the jobs.

I’m not saying a wealth tax is wrong or off the table. I’m saying treating a wealth tax like a punishment for being stupid enough to believe in the American Dream is really, really bad policy. 

Have you ever read the stories (or saw the documentaries) on how some of these super rich got rich? Bill Gates worked non-stop at Microsoft for decades. He licked Tang out of his hand while working. Yes, without the water! Just so he could stay at his computer a few minutes more writing code. 

Steve Jobs was tireless in his pursuit of creating excellent products. Jeff Bezos is still busting tail at Amazon changing the world. The stories go on endless. A few inherited their wealth. Most busted their tail growing a business. They gave up their life to create something magnificent. And they got really rich along the way. So what did they do? Started yet another company to provide us with still better goods and services. 

Musk built his fortune from his share of ownership in PayPal. That sale funded Tesla and all the rest. A wealth tax would take Musk and Tesla out. You can either tax the rich ’til there are no rich no more or you can have environmentally friendly products like solar power and electric cars. Not to mention the leaps made in battery storage technology. Last I checked the folks supporting the wealth tax guys are also concerned about the environment. You can’t have both. You choose.

 

Once again I thank God it isn’t my job to fix the budget mess in Washington. I do not like the idea of higher taxes. No matter what solution is used there will be many unhappy faces in the crowd. If nothing is done the problem will continue to spiral out of control until a government collapse. Then we will cut spending while taxes skyrocket; the worst of all worlds.

From a historical standpoint income taxes are low in the U.S. That doesn’t mean taxes should be meaningfully higher. In the 1990s we balanced the budget in Washington. Perhaps that was the point where we maxed out the Laffer Curve. 

Who knows for sure? It was a different world back then. The internet was in its infancy and promising the world. The dotcom bubble filled government coffers. Fears of Y2K (remember that?) spiked business spending. The stock market kept Washington flush with cash. Today is a different world.

I laid out the issue. I leave it to you, kind readers, to decide the best course. A lively debate in the comments is my dream. Politicians read this blog and if we can come up with workable solutions, maybe, just maybe, we can make a difference while keeping the American Dream alive.

 

 

 

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14 Comments

  1. Joel on October 21, 2019 at 8:09 am

    We can fix the federal budget by funding Medicare-For-All with a 15% VAT dedicated solely to funding universal healthcare. That’s $1.1 trillion removed from current federal budget.

    Additionally, states will have to repeal their sales taxes which are regressive and make up the revenue elsewhere (i.e., income tax).

    Employers would be responsible for the entire FICA tax (15.3%) since they will benefit most from not having to offer healthcare. Total employee share of fica is similar to the amount employers spent on healthcare (~$700 billion) so I believe this makes sense to do.

    Lastly, all “income security” programs would be funded by wealth taxes but on a state level. Wealth taxes would be similar to those found in Switzerland (Cantons).

    That’s my plan…let me know thoughts.

    • Mr. Hobo Millionaire on October 21, 2019 at 10:39 am

      A VAT is still ultimately a tax on the consumer… somewhere down the line. If a 15% VAT were to be imposed, eventually, all prices would be raised by 15% or more. There are no taxes that don’t eventually hit the consumer.

      And while I don’t have an exact plan for MFA or any whole medical care plan, I do believe there has to be a way to require or account for more personal choices/accountability. If “everything is free/included” then everyone will always go to the emergency room when sick. If doctors visits are free, then everyone will go to the doctor when they have a sniffle. I’d like to see something like doctor’s visits costing $100 OOP for insured patients, but maybe that $100 covers you for a month of visits. No one would spend the $100 for just a sniffle, but if you did have to come up with the $100, it wouldn’t break you over and over if you were truly sick.

      • Katy on October 21, 2019 at 11:52 am

        I think plenty of people have enough negative feelings about seeking healthcare that “going for every sniffle” is unlikely. I think that telemedicine has a real chance at the future and could drastically decrease the cost to both providers and consumers of health care services. It is a real cost to individuals and businesses when people have to take time off work to seek medical care for themselves and their children and medical providers who work off hours are few and far between. Just this weekend a mom was telling me how their kid had a double ear infection again and trying to fit a trip to the doctor in and waste everyone’s time and their copay just so the kid can get what mom already knows they need. I’d say almost all cases of “sniffles” could be triaged by telemedicine and then handed off to a medical concierge who could arrange the needed treatment or follow up appointment.

  2. NZ on October 21, 2019 at 10:18 am

    I am just going to throw this idea out there that I have been advocating for years. We need to overhaul the capital gains tax in a way to encourage long-term holding and increase taxes. Frankly, the 1 year cliff makes no sense to me. As I was told, the original purpose of the 1 year cliff was to “discourage reckless trading”. However, I do not see why a 1 year cliff is anything other than encouragement to hold for 366 days then sell.

    A much more logical long-term capital gains is for for long-term capital gains to be a 1% reduction per year from your normal tax rate or a pre-defined tax rate. This option has two benefits. For business owners/entrepreneurs who hold their business for years, there is a low effective tax rate so we encourage business growth. For investors, there is now a yearly incremental incentive to hold long-term, but very low incentive to hold a bad investment for “another month to get better tax treatment”. Furthermore, once a person owns an investment for a long time, there is more incentive to hold for growth and not sell.

  3. Brad on October 21, 2019 at 10:45 am

    Let’s start with term limits for Congress and the Senate. When you’re a lame duck that is about to be term limited out, you have more “political cover” to make hard choices on both the revenue and spending sides of the ledger. Take the variable of re-election out of the equation and there is more room for hard decisions.

  4. Iris Eyes on October 21, 2019 at 11:59 am

    If anyone wants to start a movement to treat corporations like persons in tax code I’m 100% there for it. There has already been success in giving (some) of them religious rights, surely at some point treating corporations as persons will become so absurd and costly that everyone will see the obvious.

    However, industry and industry groups do need to have some way to voice concerns about policies that affect their business in a way that government does need to take into consideration. We just have to figure out how to take personal gain for individual politicians out of it.

  5. J on October 21, 2019 at 1:27 pm

    If one were looking for drivers of inequity in the tax code then I still believe that it would behoove us to look at Capital Gains tax rates (section 1211 and 1212 of the code if memory serves me). Realized gains from the sale of stocks used to be taxed at 70% back in the 70s, and is now at 15% or less. This is the section responsible for Warren Buffet paying less in taxes than his secretary. It is also the section that I believe is driving the accelerated rate of net worth change in the ultra rich since the 70s. I do not believe that most Americans have a real issue with people like Gates, Buffet. Bezos, Musk, etc paying the taxes that they are when considering that they are actually building tangible value. It is those who only make an outsized net worth solely on stock appreciation that I believe we should be looking at. For example, hedge fund managers who buy and sell stocks for a living end up bypassing normal payroll tax rates because of this section. Back when I was getting my grad degree I took classes with a tax professor who has been trying to work on getting Congress to take up and pass a bill to plug that particular hole in the code, but the effort always conveniently dies in a committee. I’m not suggesting that we go back to the era of a 70% tax on capital gains, but I do believe that the pendulum has swung too far in the opposite direction.

    • Jason on October 30, 2019 at 10:35 pm

      I kinda liked Herman Cains 999 plan- 9% corporate, 9% earned income, 9% consumption/sales for all.

      Seems to truly balance for all and removes the intellectual games of calculating taxes after finding write offs, exemptions, expenses, donations, credits for this and that, etc…

  6. Mike on October 21, 2019 at 2:25 pm
  7. Ray on October 21, 2019 at 4:23 pm

    How did trumps tax reductions for the wealthy go last time?

    Spur growth?
    Reduce the deficit?

    Laffer is widely discredited by the majority of economists, whom all Acurate predicted the outcome of the last cuts

    Remember this when America was great tax rates were up to 90% on the wealthy

  8. Jay on October 25, 2019 at 7:41 am

    Seems to me if I was a billionaire getting taxed 8% a year just to breath American air, I would be looking very seriously at relocating to a more friendly place. And take my billions with me.

  9. The Social Capitalist on October 27, 2019 at 10:43 am

    Great article from an expert. So many places to start from..
    Wealth tax? How about fair taxation? You mentioned Corps are people too. They should pay same tax rates ( modified by size if company.)
    Real estate should be subject to FICA/Medicare taxes if profit is realized. I have real estate so this would hurt.
    Cap gains/dividends should be taxed as ordinary income in every way. (Wanted to scream this) Workers inherently risk life and limb daily to earn a wage but that risk is somehow less important than capital risk? I receive a some cap gains so I will lose out.
    Taxation is directly tied to where money is earned. Corporations. I agree that they should get out of HC and the VAT makes sense. Some opinions here seem to be fear mongering against national healthcare – which we already haveMedicare anyone?) but only for the old. Ageism. The problem with nationalized medicine is that corporations and doctors effectively lobby so that govt. cannot set rates ( a form of taxation). This is because Corps are people too- I am willing to join the class action lawsuit that either makes them pay the people’s tax rate or redefines persons back to living sentient beings known as Homo sapiens.

    Your points on spending and hatred of taxes are valid. But we can cut waste when we take corps out of govt. Not easy to do since historically they have been one and the other (Jamestown founded by Virginia Company-another art. for another time.) And no I don’t dislike billionaires. But they make more than they should through loopholes that favor the rich. Elon Musk would so no different if it were just a billion dollars in compensation. If companies can inflate compensation with stock buybacks then that should be taxed at same rate as a paycheck. With CEO pay at 278-1 vs. 20-1 40 yrs.ago it is quite clear where the money and thus tax avoidance is going.

    Already took long a ramble. But I look forward to future insights TWA.

  10. Adrian Lawrence on October 29, 2019 at 8:42 am

    It never ceases to surprise me how the same issue keep coming forward, high taxes just don’t work, if you look around the world, the countries with the highest living standards have the lower taxes. High tax just kills business and starves entrepreneurs of cash. It is not as if the Government is actually good at spending money, taxes nearly always end up being spent on layers of management and never hardly reach the places that they are actually needed.

    • Ray on October 29, 2019 at 9:25 am

      Please share some data that backs up this claim

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