En­slaved by tax-rate rhetoric

The Washington Times Weekly - - Commentary -

We could def­i­nitely use an­other Abra­ham Lin­coln to eman­ci­pate us all from be­ing slaves to words. In the midst of a his­toric fi­nan­cial cri­sis of un­prece­dented gov­ern­ment spend­ing, and a na­tional debt that out­strips even the debt ac­cu­mu­lated by the reck­less gov­ern­ment spend­ing of pre­vi­ous ad­min­is­tra­tion, we are still en­thralled by words and ig­nor­ing re­al­i­ties.

Pres­i­dent Barack Obama’s con­stant talk about “mil­lion­aires and bil­lion­aires” need­ing to pay higher taxes would be a bad joke, if the con­se­quences were not so se­ri­ous. Even if the in­come tax rate were raised to 100 per­cent on mil­lion­aires and bil­lion­aires, it would still not cover the tril­lions of dol­lars the gov­ern­ment is spend­ing.

More fun­da­men­tally, tax rates, what­ever they are, are just words on pa­per. Only the hard cash that comes in can cover gov­ern­ment spend­ing. His­tory has shown re­peat­edly, un­der ad­min­is­tra­tions of both po­lit­i­cal par­ties, that there is no au­to­matic cor­re­la­tion be­tween tax rates and tax rev­enues.

When the tax rate on the high­est in­comes was 73 per­cent in 1921, that brought in less tax rev­enue than af­ter the tax rate was cut to 24 per­cent in 1925. Why? Be­cause high tax rates that peo­ple don’t ac­tu­ally pay do not bring in as much hard cash as lower tax rates that they do pay. That’s not rocket science.

Then and now, peo­ple with the high­est in­comes have had the great­est flex­i­bil­ity as to where they will put their money. Buy­ing tax-ex­empt bonds is just one of the many ways that “mil­lion­aires and bil­lion­aires” avoid pay­ing hard cash to the gov­ern­ment, no mat­ter how high the tax rates go.

Most work­ing peo­ple don’t have the same op­tions. Their taxes have been taken out of their pay­checks be­fore they get them.

Even more so to­day than in the 1920s, bil­lions of dol­lars can be sent over­seas elec­tron­i­cally, al­most in­stan­ta­neously, to be in­vested in other coun­tries, cre­at­ing jobs there, while mil­lions of Amer­i­can are unem­ployed. That is a very high price to pay for class war­fare rhetoric about tax­ing “mil­lion­aires and bil­lion­aires.”

Make no mis­take about it, that kind of rhetoric wins votes for po­lit­i­cal dem­a­gogues, and votes are their bot­tom line. But that is to­tally dif­fer­ent from say­ing that it will bring in more tax rev­enue to the gov­ern­ment.

Time and again, at both state and fed­eral lev­els, in the coun­try and in other coun­tries, tax rates and tax rev­enue have moved in op­po­site di­rec­tions many times. Af­ter Mary­land raised its tax rates on peo­ple mak­ing a mil­lion dol­lars a year, there were fewer such peo­ple liv­ing in Mary­land, and less tax rev­enue was col­lected from them.

In 2009, many peo­ple spe­cial­iz­ing in high fi­nance in Bri­tain re­lo­cated to Switzer­land

Tax rates and tax rev­enue have moved in op­po­site di­rec­tions many times. Af­ter Mary­land raised its tax rates on peo­ple mak­ing a mil­lion dol­lars a year, there were fewer such peo­ple liv­ing in Mary­land, and less tax rev­enue was col­lected from them. De­spite po­lit­i­cal dem­a­goguery about “tax cuts for the rich,” in hu­man terms the rich have less at stake than work­ing peo­ple. Pre­cisely be­cause the rich have so many ways of avoid­ing taxes, a high tax rate is likely to do them far less harm than it does to the econ­omy, on which mil­lions of peo­ple de­pend for jobs.

af­ter the Bri­tish gov­ern­ment an­nounced plans to take 51 per­cent of high in­comes in taxes.

Con­versely, re­duc­tions in tax rates can lead to more tax rev­enue be­ing col­lected. Af­ter the cap­i­tal gains tax rate was cut in the United States in 1997, the gov­ern­ment col­lected nearly twice as much rev­enue from cap­i­tal gains taxes in the next four years as in the pre­vi­ous four years.

Sim­i­lar things have hap­pened in In­dia and in Ice­land.

There is no au­to­matic cor­re­la­tion be­tween the direc­tion in which tax rates move and the direc­tion in which tax rev­enues move. Nor is this a new dis­cov­ery.

Back in the 1920s, Sec­re­tary of the Trea­sury Andrew Mel­lon pointed out that peo­ple with high in­comes were sim­ply not pay­ing the high tax rates that ex­isted on pa­per, be­cause they were putting their money into tax shel­ters.

Af­ter the tax rates were cut, as Mel­lon ad­vo­cated, in­vest­ments flowed back into the pri­vate econ­omy, pro­duc­ing higher out­put, ris­ing in­comes, more tax rev­enue and more jobs. The an­nual un­em­ploy­ment rate in the next four years never ex­ceeded 4.2 per­cent, and in one year was as low as 1.8 per­cent.

De­spite po­lit­i­cal dem­a­goguery about “tax cuts for the rich,” in hu­man terms the rich have less at stake than work­ing peo­ple. Pre­cisely be­cause the rich have so many ways of avoid­ing taxes, a high tax rate is likely to do them far less harm than it does to the econ­omy, on which mil­lions of peo­ple de­pend for jobs.

Thomas Sow­ell is a se­nior fel­low at the Hoover In­sti­tu­tion, Stan­ford Univer­sity.

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