Advancing a Free Society

Playing Politics with a Sick Economy

Sunday, September 18, 2011

President Obama on Monday will propose raising the tax rate on those who earn more than $1 million as a way to reduce the deficit. This plan is being called the “Buffett Rule,” after the billionaire investor whose New York Times op-ed decried the fact that Buffett’s secretary paid a higher rate than he does.

You don’t have to be an economist to see that this idea is nothing more than populist politics, an attempt to exploit class envy and divide Americans in order to divert attention from two and a half years of failed economic policies that have left us with record debt, deficit, and unemployment levels. The focus on tax rates thus is a red herring, since raising revenues, not comparing tax rates, is what’s important. After all, a rate of 20% on $100 yields $20, whereas a rate of 10% on $1000 yields $100. But wouldn’t raising the rate on that $1000 to 20% double revenues? No, history shows us, since people will find ways to avoid paying the higher rate, especially the rich, who can afford the tax lawyers, accountants, and other expensive professionals who know how to reduce taxable income.

History also shows that reducing the tax burden on high earners yields more revenues. Consider what happened after Ronald Reagan’s tax cuts. In 1981, the top 1% paid 17.58% of all federal income taxes; in 2005, this same cohort paid 39.38%. In 1981 the top 1% paid $94.84 billion (in 2005 dollars); in 2005 they paid $368.13, an increase of 288%. Of course, during this same period taxes paid by the bottom 75% went from 27.71% of all tax revenues to 14.01%. More recently, the Bush tax cutes resulted in a 44% increase in revenues from 2003-2008. “The only conclusion,” Arthur Laffer wrote in 2008, “one can come to is that by raising statutory tax rates on the rich as proposed by the Democrats, the effective individual income tax rate won’t change, but the comprehensive household income earned by this group will fall, thus resulting in a sharp decline in tax receipts from the very highest income earners. If you want to get more tax revenues from the rich, you’ve got to make the rich richer, and to make the rich richer, you’ve got to lower tax rates.”

One more point to keep in mind when considering raising tax-rates is, what will the money be used for? Research has consistently shown that every dollar of increased revenue leads to more than a dollar in spending. Despite promises to reduce deficits or the debt, “Politicians will always spend every penny of tax raised and whatever else they can get away with,” as Milton Friedman once said. They may call it “investment in infrastructure” or “investment in the future,” but in reality the money is spent on pork dispensed to political supporters or clients. Just look at the bankruptcy of solar panel manufacturer Solyndra, an “investment in clean energy” that has left the taxpayers on the hook for half a billion dollars.

Rather than obsessing over comparative tax rates, the administration needs to promote job-creation by making it easier for businesses to innovate, invest, and expand. But targeting “millionaires and billionaires” is really about redistributing income to one political faction’s clients. And this is another lesson of history: when democracies go bad, unscrupulous leaders arise to foment class hatred by pandering to those who, as the historian Polybius wrote, are “habituated to feed at the expense of others, and to have [their] hopes of a livelihood in the property of [their] neighbors.” That is what the “Buffet Rule” is all about.

(photo credit: L D M)