Monday, July 4, 2011

Why we tax the rich

It's extremely odd listening to the rhetoric at the moment where even the suggestion that a subsidy ("tax break") on what's ultimately very much a luxury item (corporate jets) might be closed is considered "class warfare". It doesn't make much sense on any level that this is "class warfare", but the label is repeated so often by many on the right that you have to wonder why they think that.

Virtually every modern democracy has a progressive tax rate. The term "progressive" here could be defined as having two meanings - on a technical level, it's progressive in that the more you earn, the progressively large a portion of your earnings you're supposed to pay back to society. And it's progressive in that it's considered a progressive ideal, a step towards a utopian society where a leveling of the playing field is a necessary goal to bring peace, prosperity, and freedom from want for all.

But let's forget about the latter aspect, and concentrate on whether a healthy society is better off with progressive tax systems. The arguments for and against can be summarized as follows:

  • The rich, pretty much by definition, benefit more from society than the poor, and therefore should pay more towards its upkeep.
  • The rich can afford higher taxes. If I take away a person who's earning $1000 a month half his salary, the chances are he'll not be able to pay for food, shelter, and necessary resources. If I take away half the salary of someone earning $1,000,000 a month, well, that person's still going to be living an extremely comfortable lifestyle.
  • Higher taxes generally fall upon wealthy businessmen. If wage rises have diminishing returns, then those same people will be encouraged to evaluate whether an increasingly minor rise in personal income is worth it if it has a disproportionate effect on the businesses they run.
  • It's frequently argued that higher taxes are unfair, because richer people have earned every penny of their income.
  • It's sometimes argued that richer people are going to spend their money anyway, so it'll trickle down to the not so rich.
  • It's frequently argued that if those with high wages have more money, they'll invest more of it in their businesses.
I agree with all of the points in the "for" section, and none of those in the "Against". I'll explain why for each point.

The rich, pretty much by definition, benefit more from society than the poor, and therefore should pay more towards its upkeep.

I tend to think the above point is so self-evident that it barely deserves explanation, but it does have arguments against. The key word above is "society". The argument against is that taxes don't go to "society", they go to "government", and government spends disproportionately - through welfare, unemployment, social security, medicare, etc - on the poor. This ignores the fact though that the taxes that are collected to support those specific programs are taxes being raised to fund society, not government. It happens that we use the power of government to administer those social programs, but that doesn't change where the money is flowing.

Now, obviously, it's easy to see government programs that aren't social, such as the military, but even there, it's pretty obvious that the military is defending something of more value to someone when it's defending a large amount of property and/or an infrastructure to bring in a huge amount of income than it is when it's defending little infrastructure and a small house.

There's also a practical side to contributing one's fair share to the society one lives within: the rich also benefit from a stable society free of serious want. Nobody in their right mind wants to live in a country where a significant proportion of their neighbors are desperate. How many would argue that those self same people who want a stable society to live in, to protect the infrastructure that keeps them wealthy, shouldn't pay what needs to be paid to bring that stability into place?

The rich can afford higher taxes

Again, this is an argument that should be seen as self evident, and I suspect actually it is. Most arguments against this are usually by accident when a critic of higher taxes is actually arguing something else. As in "Oh yeah, let's have higher taxes, then rich people will be forced to send their money to Barbados."

That's not really a counter argument. Nobody's being forced to send their money to an off shore tax shelter - people who do so are trying to "protect" a class of living, not preventing themselves from going into bankruptcy - and, besides, tax shelters aren't as attractive as frequently claimed. The money that's sent into a tax shelter isn't easily accessible, and unless taxes are obscenely high (like the 90% rates we saw in Britain during the 1970s), the principle of diminishing returns certainly applies here.

There's a simple, unavoidable, practical argument here. If we take two people, one earning $20,000 a year, the other earning $250,000 a year (to use a figure many on the right claim is not a high wage), if I lose half my earnings (in taxes), will it cause immense hardship? For the person on $20k, the answer is "almost certainly". For the person on $250,000, the answer is "no way."

Now, there is one thing I'd like to add here. Obviously if someone has been taxed at 30% on their income all of their lives, and has entirely legitimately made long term financial decisions based upon an assumption they'll continue to have a similar net income for a while, then raising their taxes to, say, 50%, overnight, is obviously going to cause hardship. It might mean that a mortgage suddenly becomes difficult to pay, for example. But a small increase, or a series of small increases over a decade, are not going to cause that kind of problem. And I hear no-one arguing for a sudden doubling of income taxes for the very wealthy.

People will be encouraged to evaluate whether an increasingly minor rise in personal income is worth it if it has a disproportionate effect on the businesses they run.

This is one of the strongest arguments to be made in favor of higher taxes and yet I rarely hear anyone express it. Indeed, the exact opposite argument - that raising taxes will mean business people will have less money to invest - is more often the one that people hear.

One little bit of evidence of this can be seen in the disproportionate wage rises since the 1970s. As taxes on upper incomes were reduced, the gap between wage earners has massively increased. With no incentive to put their companies first, those with the power to set their own salaries have raced to the bottom to get as much money out of their companies, and into their bank accounts.

Was this wrong? It's hard to say, but it's also true that we're in the rather odd situation where we see people running companies into the ground - from the .com excesses during the 1990s to the banks in the last decade - being rewarded with ever higher salaries, with most outsides, quite legitimately, wondering if there are any incentives whatsoever to run a business for the benefit of its shareholders, customers, and employees.

What about the counter arguments?

Higher taxes are fair, even ignoring the fact they made their money within the society they're paying taxes for, because richer people are rarely worth what they're paid

This one's controversial in some quarters, but really large salaries come down to luck and not a lot else. I'm not arguing that everyone should be paid the same as everyone else, but there's clearly something wrong when someone's working six days a week, ten hours a day, and barely making minimum wage, while someone else, through a series of accidents that started at birth, gets to work a few days a week and earn millions. I'm not arguing that millionaires aren't hard workers, most are, but it's frequently underestimated what the work differential is between those on the highest incomes, and those on lower incomes.

Money doesn't trickle down, it trickles up

The argument that money trickles down is generally based on the idea that a wealthy person will buy a much bigger home, a private yacht, and that as they spend their money, everyone they spend money on will get richer.

Unfortunately this argument doesn't actually make a lot of sense. Let's go through the problems with the whole "rising tide" thing:
  • The amount of "stuff" someone with wealth needs isn't generally that exceptional, or much larger than what someone without it needs. So the number of jobs created is actually somewhat small.
  • The industries those jobs create are subject to the same constraints. A tiny group of people take huge amounts of money out of the businesses, everyone else gets whatever's left.
  • The rich have more money to spend on non-productive property. For example, the rich could spend a large amount of money on land. This doesn't in any way increase jobs, indeed, by removing resources from the economy that could be put to work, it reduces the ability of an economy to create and sustain jobs.
There are additional problems. With demand being limited to small numbers of big ticket items, rather than large numbers of smaller items, prices rise for everything that's not an absolute necessity (ie not something everyone's going to buy anyway.) To put it another way, imagine if the only people who would ever be able to afford plasma TVs, whether you make them in factories pumping out a million a year, or hand craft each from the finest oak and the love of a master craftsman, are the extremely wealthy. Would there be an industry of any size making plasma TVs? Without that large industry, would there be the jobs created by that industry? Without the jobs, would wages ever rise to levels that make mass produced plasma TVs become affordable?

Arguing that money should be concentrated in the hands of the wealthy because it'll eventually make its way to everyone else is arguing for an end to the gains made since the industrial revolution, as a world where money is widespread is a world where economies of scale make economies grow. Money never trickles down, it trickles up.

Raising taxes encourages people to spend money on their own businesses

I posited a related argument above, but here's the thing. How do I know that investing in a business you own is a great thing to do if you have higher taxes?

Well, because that's how the tax system is set up. I own a business. When I spend money I earn on my business, it becomes tax deductible, and it doesn't matter if I'm earning a billion dollars a year, or $100,000. And thanks to a progressive tax system, the more I spend on my business, the less of a proportion of what's left gets taxed!

Class warfare? It'd be class warfare if, y'know, this was about class, not income, and if it involved warfare, not taxes. This is about an economy that needs a few less moral hazards, and a society that supports itself.

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