Incentives matter

I recommend reading Alan Reynolds’ piece in Wall Street Journal Opinion today, Why 70% Tax Rates Won’t Work.

The table below from the article says it all.

With some wide range of experiences on where the tax rates have been set, there really wasn’t much difference in the tax revenues generated as a percent of GDP.  The high-end outlier was, counter-intuitive for most, on the lower end of the tax rate experience.

Alan Reynolds sums it up:

Still, pundits cling to the myth that lower tax rates mean lower revenues. “You do probably get a modest boost to GDP from tax cuts,” concedes the Atlantic’s Megan McCardle. “But you also get falling tax revenue. It can’t be said too often—and there you are, I’ve said it again.”

Yet the chart nearby clearly shows that reductions in U.S. marginal tax rates did not cause “falling tax revenue.” It is not necessary to argue that tax rate reduction paid for itself by increasing economic growth. Lowering top marginal tax rates in stages from 91% to 28% paid for itself regardless of what happened to GDP.

Do pundits ignore this evidence?  Do they think there’s something wrong with it?

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Let’s Thank the Top 1%

Alan Reynolds makes a great point in his opinion piece, Taxes and the Top Percentile Myth, in the Wall Street Journal today.

Arguments for these retaliatory tax penalties [reinstating pre-Bush tax rates] invariably begin with estimates by economists Thomas Piketty of the Paris School of Economics and Emmanuel Saez of U.C. Berkeley that the wealthiest 1% of U.S. households now take home more than 20% of all household income.

This estimate suffers two obvious and fatal flaws. The first is that the “more than 20%” figure does not refer to “take home” income at all. It refers to income before taxes (including capital gains) as a share of income before transfers.

Reynolds’ first fatal flaw is obvious and I’m surprised that I haven’t heard it before.  Though, I wish Reynolds would have provided the share of actual take-home pay for the top 1% to illustrate how tax rates impact the gap between rich and poor that the left.

I performed some math on the numbers from this link and I estimate that while the Top 1% earned 20% of income in 2008 (or AGI), their after-tax income makes up 17.5% of total after-tax income.

This point also reminds me that when talking poverty statistics, we again usually talk only about taxable income.  We rarely adjust for the value of the sources of assistance received by government and/or private charities.  This seems odd, since the main point of the government programs is to help alleviate the poverty conditions.

Now, I think I know why Reynolds didn’t provide the number.  I’m not sure many on the left would find a 2.5 percentage point “leveling of the playing field” compelling.

Reynolds does go on to point out that:

…no other major country is dependent on so few taxpayers.

And Reynolds references a 2008 OECD study that concludes:

“Taxation is most progressively distributed in the United States…”

This bolsters two points I like to make to those who complain that the tax code is not progressive enough.

First, I point out that it is polite to thank those Top 1% earners for shouldering so much of the cost of government for us.  The left claims  that government, or society, makes their riches possible (they should read Hayek).  I like to point out that their riches make the government we have possible.  If a wealthy person picks up the tab for 40% of your dinner, you should thank them.

Second, I like to ask them how progressive should we be?  I’d like to know what they think is the ideal spread of income and taxes so we’ll know when we get there.  Even though the OECD says we have the most progressive income tax system, we apparently aren’ t progressive enough for progressives.  Failing to ask them to state their desired goal lets them always say, “we should be more progressive.”

The second fatal flaw Reynold’s points out in the Top 1% data isn’t so obvious, but it’s still a good point.  The point is that tax rates influence the types of income that are reported.  Put a high tax rate on income, and the wealthy will take more of their income as capital gains, which is taxed at a lower rate, or won’t report income at all.  They’ll hold it long-term in stocks.

Building from this, Reynold’s final point is that if we seek to increase the share of taxes paid by the wealthy, we may come to find that they will not report as much income and they’ll pay a smaller share of taxes, which Reynolds calls an

…ironic consequence of listening to economists and journalists who form strong opinions about tax policy on the basis of an essentially irrelevant statistic about what the top 1%’s share might be if there were not taxes or transfers.