Saturday, June 21, 2008

Taxing High Wage Workers More Heavily Makes Good Politics but Lousy Economics

Over the past decade, it has become fashionable to bash high income earners in the name of equity. For example, Omaha investor, Warren Buffet, receives high praise from big spending bureaucrats when he claims that the rich should pay higher taxes. He bases his assessment, in part, on the fact that he is paying a lower tax rate than his secretary. However, he fails to distinguish between taxes on wage income from capital income. That is, the reason he pays a lower tax rate than his secretary is that his income is derived primarily from stocks which are taxed at 15 percent, while his secretary, as most Americans, pays taxes on labor, which is taxed at much higher rates.

For example take four 2006 taxpayers, Andrew who receives $250,000 from wages, Betty who earns $250,000 from dividends on stock, Charlie who earns $25,000 from wages, and William whose wealth grows by $250,000 due to an increase in the value of his Berkshire Hathaway stock. In terms of federal income taxes including social security, Andrew would pay $76,934, or a 31 percent rate, Betty would pay $33,700, or a 13.5 percent rate, and Charlie, the low income individual, would pay $2,671, or a 10.7 percent rate. Interestingly, William would owe $0 in federal income and social security taxes. Furthermore if William donates all of his stock to a charitable foundation, such as the Bill and Melinda Gates Foundation, his accumulated wealth is never subjected to individual income taxes. One can easily see the economic penalty for earning high income from wages. Given this disparity, it is not surprising that the Tax Foundation concluded that the top 10 percent of income earners, households with income greater than $100,000, paid 70 percent of federal taxes for 2006.

However, facts have not stopped a parade of politicians from railing against the “rich.” In the name of fairness, presidential candidate Obama has said he would let President Bush’s 2001 tax cuts lapse for families earning more than $250,000. And, speaking at a Senate Finance Committee hearing, the fourth ranking Democrat, Senator Schumer from New York, reiterated his opposition to any tax hike on capital, saying it would unfairly hurt New York's economy. But he indicated he was willing to tax high income Americans who earn their incomes via wages. So there does appear agreement between Obama and Schumer in terms of more heavily taxing high income WAGE earners, thus allowing lower income individuals, and high income CAPITAL recipients to continue to pay less than their proportionate share of the federal tax burden.

There are three problems with this distribution of burdens. First, politically speaking a large number of low income individuals (the 90 percent) can vote to inflict even higher taxes on the supposed rich (the 10 percent). Second, this shifts the cost of government to a small proportion of the population and thus encourages government overspending. Third, taxing higher wage earners reduces overall economic growth by discouraging work and entrepreneurship thus reducing the size of the economic pie for all, including the poor. That is, high economic growth enhances the quality-of-life for low income families more than elevated government spending.

Not only would repeal, or the failure to extend, the Bush tax cuts penalize the more productive and harder working individuals (yes there is a connection between pay and productivity), it would lower overall income for all. A recent investigation of the 2001 Bush tax cuts by the U.S. Treasury concluded that the tax reductions were good for overall economic growth ushering in six years of uninterrupted growth. Furthermore, the tax cuts that were the most effective at generating growth were those that liberals argue go to the wealthy. The least effective tax cuts, according to the Treasury analysis, were the reductions at the lowest end of the income spectrum (the 10% bracket) and the child care credit. Unfortunately, these are the only ones Obama wishes to retain.

With all the political hyperbole about how high income earners are not paying their fair share, politicians and journalists should level with the American people about who is bearing the lion’s share of the cost of government. Furthermore in order to fuel economic growth, elected officials should more equitably spread the burden of government by requiring lower wage individuals to pay a larger share of the cost of the federal government. My proposal makes lousy politics in a public forum increasing dominated by economic relativism chatter, but it makes good economic sense in terms of growing the economic pie more quickly for all, both rich and poor.

Ernie Goss

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