There's been a lot of talk about "taxing the rich" recently. The idea seems to be that taxes from "the rich" can provide more revenue to the government without any negative economic consequences. Usually "the rich" are people making more than $250,000 in income, and the proposal is to increase their marginal rate to at least the old marginal rate of 39.6%.
But who are "the rich", really? Well, there are probably very few single people who make over $250,000 - less than 10% of the returns in the top tax bracket are filed by singles, as opposed to over 40% of all returns - so it's mostly likely a married couple. And most likely it's a married couple who both work - like two doctors or two lawyers - so that their combined income comes in above $250,000, even though neither of their individual incomes does.
So let's take a look at the situation one of these couples is in. The husband, say, is a specialist physician making $180,000 a year after adjustments to income like malpractice insurance. The wife is a general practitioner making $140,000 a year after adjustments. The total is $320,000 a year, which puts the couple well above the $250,000 cutoff proposed for "the rich".
So what's the wife's effective take home income from working? Well, she makes $140,000 per year. $69,460.70 of that is paid in taxes - $44,737.50 federal, $7420.00 Massachusetts state, $17,303.20 self employment. She pays a nanny $20 an hour for the 50 hours per week that she works, plus for her 2 hours a day commute; subtracting a $3000 child care credit, that's $57000. Leasing a BMW is $500 a month - the nanny uses the Cayenne to cart the kids around during the day - so that's another $6000 a year.
After subtracting all those work related expenses, she actually only takes home an extra $7539.30 in disposable income per year - barely more than 5% of her taxable income. No wonder most mothers in the U.S. stay home rather than work! But that's okay, our doctor enjoys her job and enjoys helping people. It's true that she'd rather stay home with the kids, but that's only worth $500 a month - $6000 a year - to her since her work is also rewarding. $7539.30 is enough to keep her working - barely.
Now, let's bump up the tax rate on the half of her income that causes the couple's combined income to come in above $250,000. We'll bump the rate from the present 33% to the former top rate of 39.6%. Her taxes increase by $4620. Her disposable income drops to $2919.30. That 6.6% increase in taxes may not have seemed like a big number, but it cuts our doctor's effective take home income by more than half!
Here's the kicker. Taking home $2919 is no longer enough to keep her working. So she quits, fires the nanny, and stays home to take care of the kids. That means she not only quits paying that extra $4620 in taxes - she also quits paying the original $44,737.50 in federal taxes as well. The government is also out the social security taxes, the state taxes, and the taxes the nanny paid.
Now, not everyone in that situation will quit. Some will go ahead and pay the extra taxes - maybe they feel that a different kind of work during the day will make them be fresher for the kids and appreciate them even more when they're home. But not a lot have to quit to make the supposed revenue benefit of the tax increase disappear, or even become a revenue loss.
Statistics on returns of various types that were in various tax brackets are here: http://www.irs.gov/pub/irs-soi/05inrate.pdf
Nanny rates are $17-$25 per hour: http://www.tandcr.com/candidate/articleSalary.html
Doctors work an average of 51 hours a week: http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a1tbL9.eTmrk
Estimates for doctors' incomes vary all over the place. The above link suggests that GPs make $173k per year. A comment at this link puts malpractice insurance at $34k per year: http://www.hcplive.com/primary-care/articles/doctor-average-hourly-wage-2772
My spreadsheet for calculating this stuff: http://www.powderhouse.com/~wdew/articles/psychohistory/taxing_the_rich.xls
Presumably the negative consequences that you point out here would also apply to raising taxes on people in the middle-class. It seems likely that the negative economic consequences might even be greater in that case. So, if you wanted to raise taxes while minimizing the economic consequences, it seems like raising taxes on the rich is a reasonable plan. There may be other taxes which had even less economic impact such as a value added tax but they tend to be less progressive as well.
Really what I'm pointing out is that "the rich" actually are middle class - most people consider doctors upper middle class, rather than "rich". To put it another way, increasing taxes on tax returns making over $250,000 mostly consists of raising taxes on a select subset of individuals, mostly women, making more than somewhere around $125,000, probably starting around $75,000 or so.
Well, that plus pointing out that raising those tax rates will likely result in a reduction in revenue rather than whatever increase is projected.
It's absolutely a valid point that there will be some negative economic consequences from any tax increase; I'm addressing this particular proposal because it's the only concrete proposal that's currently being floated, as far as I know.
You bring up a good point about value added taxes. I think there are reasons why value added taxes might become more suitable as an economy shifts from an industrial economy to a services based economy, but that's a topic for another post.
Edited at 2010-09-03 01:44 pm (UTC)
It's definitely true that $250,000 is somewhat arbitrary and possibly low if what you're targeting are the "rich", especially given the fact that married couples have their income combined for tax purposes.
And, it's definitely worth considering what the actual revenue effects will be from a given tax increase. I think the math for your example is valid. The real question is how many people will actually fall into that category. Presumably there are also other people who will work harder to earn more money to make up for the additional money lost to taxes. I'm not going to claim that this is a bigger factor: just pointing out that the analysis is more complicated. I could write up a use case about a doctor who is thinking of retiring early but now decides to work an extra couple years to make sure that she has enough savings given the increased taxes.
It would be interesting to see figures on what proportion of taxes are paid on income over $500,000 or $1,000,000.
That said, I think dcltdw is correct that the really rich are more affected by various loopholes rather than by tax rates. For example, they can use the charitable donation of appreciated assets rules to double the tax benefits of charitable donations - which essentially means they can donate half their income and take the other half tax free. Closing loopholes like that would be much more effective in getting the truly rich to pay taxes.