Do the Rich Pay Their Fair-Share of Taxes?

Target the Rich!              (c) Can Stock Photo

The far-left in the United States — including President Barack Obama and the two Democratic Party candidates, Bernie Sanders and Hillary Clinton — delight in demanding the very rich pay their “fair-share” of income taxes. The questions for this essay are: 1) How much do the really rich really pay? 2) How much should they pay? and 3) How much will it hurt the nation to ask the rich to pay more?   

Democratic Party Positions on Taxes

Before I continue to address these questions, I should respond to what I think would be a wide-spread reaction to what I wrote above. Namely, many would say to me, “How dare you accuse Obama and Clinton of belonging to the American far-left?” I suspect most everybody agrees the democratic socialist Bernie Sanders is pretty far to the Left, but many (especially in the main-stream media) probably view Obama and Clinton as moderates.

Yet, President Obama recently gave a speech in Buenos Aires to an audience of Argentinian youth in which he said  there is “no difference between capitalism and communism, choose whatever works”. This statement greatly shocked Reuven Brenner, a McGill University professor in the faculty of Management, who had grown up under communism and who had seen both his parents arrested on false charges. Obama’s statement motivated Brenner to write,

How can a president of the US get it so wrong?  And just 30 years after communism fell?  Or without so much of [sic] correcting himself saying: “Though remember, Germans believed that fascism worked for the German tribe for a while, and communism had its Gulags and starved millions, and don’t forget all the people who disappeared under Latin American dictatorships, communist or other, or radical Islamism, for that matter.  So perhaps I misspoke.”  No, there is no such correction in his speech.  Obama’s statements make Bernie Sanders success and repeated call for “revolution” before screeching crowds more comprehensible.  The lack of outcry is actually deafening.

In addition he wrote

Hard to know what is more shocking: A president of the United States stating in a Buenos Aires speech last week that there is “no difference between capitalism and communism, choose whatever works” … or the fact that this statement has not received coverage.

The deafening silence of the main-stream media on Obama’s speech does indeed speak volumes about their own ideological persuasions. Also, as I noted in Economic Plans of Trump, Sanders, and Clinton Are Fantasies, socialism has never worked well, and there are excellent reasons for believing it never will.

For almost all of his two terms in office, Obama has called for much higher taxes on the rich.

Hillary Clinton on the other hand started off her campaign moderately just left of center, but has been pushed ever farther toward the Left by Bernie Sanders. Examples of leftward drift in her positions include opposition to the Trans-Pacific Partnership treaty, as well as a change of position to oppose the Keystone XL pipeline. Concerning taxes Hillary Clinton has staked out the following positions:

1. The Wealthy pay too little, and the middle class pays too much.
2. There should be no tax increase on people earning under $250K.
3. Raise capital gains tax by no more than 20%.
4. Rescind Bush tax cuts for those making more than $250K per year.
5. Cut taxes for the middle class.

I hope to persuade you later that all of these positions,  other than the last one of cutting taxes on the middle class, are short-sighted and would be counterproductive.

Bernie Sanders would treat the rich even more harshly with taxes. His tax proposals include:

1. Eliminate tax loopholes, especially for corporations.
2. Increase top tax rates on the wealthiest to above 50%, but below the 90% rate under Eisenhower.
3. Decrease the lower bound on estates to be taxed on death of owners to $3.5 million for individuals and $7 million for couples
4. Increase estate tax rates to 45% on inheritances between $3.5 million to $10 million, to 50% for estates between $10 million and $50 million, and to 55% on estates over $50 million.
5. Create a billionaire surtax of 10%.
6. End family foundations of billionaires setting up trusts for inheritance.
7. Double the taxes on capital gains and dividends to as much as 40% for the wealthiest 2%.

With the exception of the elimination of tax loopholes, which is highly desirable, all of the rest of Sanders’ plans would be counterproductive for the economy for reasons I will discuss shortly.

How Much Do the Rich Really Pay?

Listening to all the rhetoric from the Left about the wealthy, especially the wealthiest 1%, one would think they are using loopholes to pay minuscule taxes. So how much do they actually pay? Last year in an April 2015 article, the Wall Street Journal produced the following table on the payment of 2014 income taxes.

The top 20% with incomes above $134,300 payed a whopping 83.9% of all income taxes; the top two-fifths with incomes above $79, 500 paid 97.3% of all income taxes. The bottom 40% had negative income tax, as the government paid them money! To get a finer scale than with quintiles, consider the following piecharts from the post Yes the Top 1 Percent Do Pay Their Fair Share in Income Taxes. The data again is for the 2014 income tax distribution.

From this data you can see the wealthiest top 2.4% paid 48.9% or almost half of all income taxes! This does not appear as if  the wealthiest are not paying their fair share!

How Much Should the Rich Pay, and What Will It Cost the Nation to Make Them Do It?

Anyone who proposes the wealthiest should pay even more in income taxes should first reckon with the harm they will impose on the economy. In the Distribution and Use of Wealth in U.S. Capitalism and in The Actual U.S. Distribution of Wealth Today, I discussed how a great deal of income and wealth inequality is required in any growing economy. The requirement that demands this inequality is the need for a large amount of investment each year if economic growth is to be realized. In fact a certain fraction of yearly total investments, called replacement investments, is required just to counter depreciation and replace worn out or obsolete capital goods, or to upgrade worker skills for more modern requirements. Unfortunately, there does not appear to be much information available on how much replacement investment is needed every year, due to the complexity of estimating how fast everything, including workers’ skills, wear out. Nevertheless, it is a very vital piece of information, because if total investments ever fall below needed replacement investments, the productive capacity of the nation will decay and GDP will fall. To get any growth at all, total investments must be larger than replacement investments to increase productive capacity.

In reality, with a mature economy such as ours, the problem is larger than just increasing total investments. If the total factor productivity, the savings rate, and rate of increase of replacement investments with increased capital, as defined in the post The Solow-Swan Model and Where We Are Economically (1), remain constant, then processes described in The Solow-Swan Model and Where We Are Economically (2) will drive the economy to a general equilibrium with constant per capita GDP. Unless something changes there would be no growth in per capita GDP. As told in The Solow-Swan Model and Where We Are Economically (3), there are three things that can change to cause per capita GDP to start to grow again. One is a reduction in the rate of replacement investment increase as capital investment increases. If less replacement investment is needed, more of the total investment can be used to increase productive capacity. A second thing that can change is an increase in the savings rate, providing a larger amount of total investment for increasing productive capacity.

However, because of the nature of economies, eventually increasing savings and decreasing replacement needs lead to diminished returns for increasing GDP. This is what happens to a mature economy. At that point the most potent way to boost GDP growth is to increase total factor productivity, which itself is a function of investment into new technology, labor-skill upgrades, and new products desired by the population. For example, when investments in the development of automobiles led to their cheap production and the replacement of horses with cars, the total factor productivity increased, allowing GDP to increase even more. In the end this is the primary way in which a mature economy can increase GDP. To manage this, one requires knowledge of what the markets want and need, as well as a knowledge of what reality allows. Given the many kinds of goods and the complexity of new technology, these are requirements no government official or finite groups of bureaucrats can hope to completely understand. An increase in the GDP of a mature economy requires both investment in excess of replacements as well as expertise in entrepreneurship and technology.

Nevertheless, an increased knowledge on how to make new products, to increase workers’ skills, or to increase the efficiency of processes — all the things needed to increase total factor productivity — require investments themselves. Therefore, everything in the end comes back to increased investments to grow GDP. To get increased investments, a generally large fraction of GDP must be saved and not consumed, and then allocated to increase productive capacity of goods and services the population as a whole wants and needs. This fact plus the additional reality that not everyone has the skill to expertly allocate capital for this purpose means capital must be concentrated in the hands of those who have proven they can perform well. Who or what should determine who gets this capital to invest and how much? In Distribution and Use of Wealth in U.S. Capitalism I claimed free-market capitalism provides the most just and efficient way to make this determination.

In fact the largest fraction of any truly rich individual’s wealth and income is almost always allocated to investments in the economy. Very little else in human experience can absorb that amount of assets. What they do is to wield the excess wealth granted them for the benefit of society. If they invest well, they gain profits for more allocations into the economy. If they invest poorly and have losses, assets are taken from them and redistributed to those who have invested more wisely. I have had more than one opportunity to note the remarkable similarity of this picture to the Christian parable of the faithful steward.

Yet this function of the very rich to allocate capital in society’s best interests can only occur if the decisions of who and what succeeds and what fails are made by a free-market. Government lacks the capacity to make decisions that result in the balance of all the demands for goods and services with their supply. Once the Government interferes and uses the coercive power of law to determine winners and losers, the economy goes into a perpetual state of unbalanced supply and demand. That kind of state is what is usually named a recession or a depression.

I have just one more major point to make. In  Distribution and Use of Wealth in U.S. Capitalism, I argued that any increase in taxes on the wealthiest would result in a similar reduction in the country’s total investments. If taxes on high income households are increased by 10% to 15% of GDP, the total investments would be reduced by similar amounts. After all, what the filthy rich consume in any one year is usually a very small fraction of their income and wealth. Therefore, if they are not saints (and how many of us are?), they could easily provide what additional is taxed by reducing the capital they invest by a similar amount, leaving their personal consumption unchanged. Is what government provides through the additional taxation worth the reduction of investments in the economy? I think many decades of historical experience all over the world gives a deafening “NO!” as an answer.

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