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.
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.
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.
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.
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.
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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