Sunday, July 20, 2008

Do the rich pay for everything?

In reply to Thought Expirement, a reader commented
It's not that I disagree entirely with you but you build your satire around the assumption of the following extremes: the "rich" pay for everything - by rich do you mean MD rich ($300k / year) or CEO ($40 million annual income) rich? In your model is there a middle class whose collective resources benefit people of similar status?

I wasn't trying to imply that the rich pay for everything, but I could understand how somebody might draw that conclusion. With a satirical post, it's not always obvious which parts are satire and which parts are direct. What I was trying to suggest is that I think there are lot of people on the left who think that it's possible to pay for everything by taxing the rich. Their logic is that if the government needs more money to fund a program, it's only a matter of raising taxes on the wealthiest Americans. I believe this is fundamentally flawed and it has to do with the nature of money, wealth, and what it means to pay for something.

In terms of direct taxes, there are lots of statistics. The National Center of Policy Analysis has an article saying the wealthiest 1% pay 35% of the taxes. There are lots of studies about that, but I don't think they tell the full story. As I said, I am more interested in getting to the deeper nature of this question.

So let's take the most extreme example: people like Warren Buffet -- the wealthiest of the wealthiest. It should be possible to pay for many government programs by taxing these people more. The reality though is that even if we doubled the taxes paid by billionaires like Warren Buffet, it would likely have almost zero impact on their lifestyles or their consumption. Warren Buffet lives an extremely simple life. According to Wikipedia, "
He lives in the same house in the central Dundee neighborhood of Omaha that he bought in 1958 for $31,500, today valued at around $700,000." I heard his typical dinner is a cheeseburger from the local diner.

So what does it mean to tax Buffet more? It pretty much means that we'll take capital that Buffet would invest in productive companies and instead give it to the government. As history has shown, governments are terribly inefficient at allocating capital. This is why socialism and communism don't lead to productive economies. Most of the money government takes in is consumed. Some of it may be used to build infrastructure like roads and bridges, but very little of it will be used to create the next generation of great companies that will help make the world wealthier. There is a good reason why companies like Microsoft, Google, Intel, and Apple are all products of the private sector. Most of the money the government takes in goes to the military or to really inefficient capital allocation like farm subsidies. Some of the money is redistributive. It may help feed some poor people today, but for the most part, it won't be a real investment in their future. Little of it will be used for productive capital that will provide them jobs in the future.

What I am trying to say is that the wealthiest wouldn't really be paying the cost of these taxes -- everybody would. There was some level of taxation that would have prevented companies like Google or Microsoft from coming into existence. And everybody would be a lot worse off without those companies. There are some companies that would currently exist if more capital had been invested by the private sector in things people want (longer lives, better education for their children, better healthcare) than those things politicians want (a military empire, corporate welfare for their cronies, lucrative lobbyist jobs after they retire, etc.,). So somewhere out there are a handful of people that aren't billionaires because they didn't get to create those companies, but that isn't the real cost to society. The people who paid those taxes were average Americans who now won't get the benefit of those companies that never were created. As Henry Hazlitt wrote in Economics in One Lesson, "The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups."

Now Buffet is the extreme example, but I believe the same is true for the majority of wealthy people whether it be the "MD rich" or the "CEO rich". Certainly, many of these people spend a lot more on consumption and lavish lifestyles than the average person. But I think the majority of these people are saving the money and investing in it like Buffet is. Many people may think of the worst excesses associated with being wealthy and that is what is often reported on television. But that is the outlier case (though the most entertaining for sure). For the most part, wealth is being invested in future production that will help improve the lives of everybody in the future. If you tax these people a little bit more, it will mostly have an unnoticeable impact on their lifestyle but have a large impact on how capital is allocated. If you tax them excessively, it can destroy the economy altogether because it takes the incentive out of making money. If my tax rate were 90% for example, there would have been very little benefit to me working hard as a software engineer. I would have hung out at the beach instead of integrating chat into Gmail. And there probably wouldn't have even been a Google or a Gmail at all because the other people I work with would have probably have been at the beach with me.

I hope I answered the question of who really pays the taxes.


mamund said...

"taxing the rich" is a straw man argument. the big change in rates over the last 50 years has been in the *corporate* tax payments collected (ignore the "corporate tax rate" straw man, too).

check it out

Jon Perlow said...

What's the impact of corporate taxes? Do corporations really pay any tax? If corporations paid zero taxes and the additional profits were just passed back to investors, would the investors now just pay taxes on that income? If those investors are pension funds, they would have a larger investment base to fund the retirements of their workers. In that case, it means that workers are paying those corporate taxes because their pension funds now have less money. If wealthy people would have received those proceeds, they would pay taxes on dividends or capital gains. Maybe that revenue is greater than the amount the corporations paid. And then there's all the corporate revenue that corporation leave with overseas subsidiaries to avoid paying taxes on the income. That money would be invested in the US economy instead of foreign economies creating more jobs for workers domestically. But maybe if corporate taxes were higher, capital would move from the United States to foreign countries. Maybe that additional capital in this country is keeping prices lower for American consumers. Maybe it's creating jobs that would otherwise move overseas.

This is the beauty of the corporate tax and why politicians love it so much. It's a way to collect taxes without even knowing who is paying for it. There's no way to know if it's being paid for by wealth investors, pension funds, 401(k)s, other shareholders, consumers, or workers. The perfect tax!

mamund said...

jon: *pensions*? you're kidding, right?

coporate taxes in 1950s were 4.8% of GDP. in this decade it's gone to less than 2% of GDP.

at the same time pensions have gone from defined benefit to defined contribution (1980s) and the unfunded liability of these private pension funds is at an all time high.

and overseas sequestering of u.s. corporation profits continues to increase.

i see no evidence that reducing corporate taxes over the last 50 years has increased pensions or reduced tax sheltering.

robfelty said...

I find it interesting that you use Warren Buffet as an example. since he recently stated that he thinks the rich should be taxed more:

"Buffett said he makes $46 million a year in income and is only taxed at a 17.7 percent rate on his federal income taxes. By contrast, those who work for him, and make considerably less, pay on average about 32.9 percent in taxes - with the highest rate being 39.7 percent."

Jon Perlow said...

I am well-aware of Buffet's stance. Obviously, I think he's wrong. But if Buffer wants to give more money to the government so they can bomb more countries or pay for more ethanol subsidies, he is free to do so. I think his money is more useful for directing capital in the free market than for maintaining a foreign empire.