Raising taxes on the rich won’t really tax them

By Nikhil Rao


The Federal Government was permitted to collect an income tax as a source of revenue by the 16th Amendment to the United States Constitution. Some argue that this violates one of the basic tenets of the Constitution’s protection of property rights.

Agree or disagree with this critique, you would be fooling yourself to pursue it in 2012. We live in a day and age where the government provides benefits to the citizenry, whether we like it or not. At the current levels of spending, it is completely foolish and unsustainable to completely do away with the concept of taxation. The “Buffet Rule,” however, is a different proposition.

It is a proposed replacement for the Alternative Minimum Tax and aims to raise the minimum tax rate for individuals making more than a million dollars per annum to 30 percent. This act, similar to Senator Harry Reid’s proposal to levy a 5.6 percent surtax on the incomes of high-earners was dubbed “Paying a Fair Share Act of 2012” and recently died in the Senate. It initially passed by virtue of accruing enough votes to satisfy the simple majority requirement but then failed to get the 60 votes (known as “cloture”) required to overcome the Republican filibuster.

I argue that this tax increase is not only largely useless but also counterintuitive as a method of deficit reduction. It merely aims to force individuals to pay their “fair share,” whatever that is. However, there are better ways to ensure efficient assimilation of tax revenue from everyone, and I shall explain this later on.

First of all, let us look at the statistics. I am a strong proponent of progressive taxation, but I find that this is not my definition of progressive. The National Taxpayers Union’s statistics show that the top one percent of American earners paid 36.73 percent of the total amount of revenue gathered from the Federal Income Tax, while the top 50 percent paid a staggering 97.75 percent. The Heritage Foundation has similar values for 2008, placing the one percent and 50 percent at 38.02 percent and 97.3 percent, respectively.

If we disregard these statistics and go by mere individual percentages, instances where richer individuals pay a lower tax rate than those less well-off are easily found. These are quickly twisted into hotly contested moral debates that completely ignore the fact that no illegal or immoral behavior has occurred. These individuals are merely paying the tax rate that is laid down for capital markets or whatever source they rely on for their methods of investment. On top of that, in the grand scheme of things, such a monstrous disparity in terms of income paid is something that should not be ignored.

I am not writing here to defend the rich or condemn the rest, but it seems to me that this ill-begotten “Buffet Rule” reeks of populism, or worse – a punishment for prosperity. I am not turning a blind eye to those who have gained untold riches by leaving their scruples behind but simply acknowledging the fact that each such individual is not inherently immoral.

When, in 2011, Warren Buffett wrote an opinion column in the New York Times urging the government to “Stop Coddling the Super Rich,” he couldn’t have been more wrong. As I pointed out in another column of mine, the rich are mobile. Why should they remain in a country that imposes stifling tax rates when they could shift themselves or their assets to a more conducive free-market haven? Like consumers who flock to products that combine quality with low prices, the rich gravitate toward the legal means to keep more of the money that they earn; why should they not?

It is touted by supporters of the “Buffet Rule” bill that increasing the tax rates would be a great method of deficit reduction. After all, is that not what the Republicans want? They say this with an almost taunting defiance, (think Russell Crowe’s “Are you not entertained?” speech from “Gladiator”). I’m afraid there are chinks in the armor of such suspect ratiocination.

Let us examine the situation that we have now. Let the amount of income that would be subject to this tax be I1 and let the tax rate be T1. Now let’s play government. Suppose that the “Buffet Rule” is enacted and the new tax rate is T2. According to my logic, one that is backed up by real events in the real world, assets of varying liquidity and rich individuals will find their ways to countries such as the Republic of Ireland and Switzerland. Rich individuals will also be incentivized to make use of loopholes in the United States’ gargantuan and exceedingly complex tax code. So we can conclude that the amount of taxable income has decreased to I2. It is clear that the income tax decreases when the tax rate increases, and we would reach a point where the revenue (rate multiplied by the taxable income) would decrease due to the predominating effect of the decrease in taxable income.

This is not new logic; this rationale was used by George Osborne, United Kingdom’s Chancellor of the Exchequer when he decreased the top marginal tax rate from 50 percent to 45 percent. I am yet to hear an unequivocal rejoinder to this model that satisfies me.

How, then, would a government proceed to efficiently extract money from its citizenry to reduce the deficit, instead of bandying about plans with low marginal utility? People tend to vacillate between a sales tax and the Value-Added Tax (VAT), but I see the VAT as clearly the more efficient. The crucial difference is that the VAT is a tax that is levied on the value added to a good at each step of the production process. The consumer still pays the amount that he or she would under a sales tax, but here revenue is efficiently extracted at each level, leaving little room for escape.

Given what I just outlined, it is then possible to lower the individual income tax rates on Americans in order to remain competitive with regard to the world while still efficiently collecting revenue. In addition to this, it would be prudent for loopholes to be closed, ensuring a complete collection. Doubts regarding the regressive nature of such a tax can be dispelled by allowing a modicum of exemption; for example, basic food and clothing items can be untaxed. This tax, effectively a consumption tax, would increase revenue while boosting the savings rate, currently at a lowly 3.7 percent. Who needs a “Buffet Rule” when you have the alternative of a method that has been tried and tested in India, the United Kingdom and the countries of the European Union?

Had the administration its druthers, it and its apparatchiks would not hesitate to tax the rich further, but I hope the futility of that course of action is now exposed. Before this column is subject to criticism, I reiterate that I am no defender or condemner of any social status; I am merely stating that it is in the country’s best interests to remain competitive while simultaneously raking in revenue. Economists proffering such views will be subject to vituperative comments in the short term but may prove to be incredibly prescient in the long run.