Why Overtaxing The Rich Is Usually A Stupid Idea - The Second In A Continuing Series

This is the second in a series of posts that we will be doing that examines how it s often stupid to unfairly overtax the rich in this country. My standard disclaimers still apply. I am not rich by most definitions of wealth. My family pays Federal income taxes in the 15% tax bracket range. We live in a pretty typical middle class, mid-size 2,000 square foot house. I drive a seven year old vehicle and my wide drives a five year old vehicle. We do not have a private jet, numerous summer homes, or a hidden mansion or two.

 Second, how much tax is “fair” is a very subjective judgment. The purpose of these related posts is not to try and persuade you of my definition of what “rich” is but to illuminate what actually could happen, and often does happen, when the political class thinks it is a good idea to drain more wealth out of the top economic producers in the country. Fair or not, changing taxes results in changing behavior, for better or worse for the “common good,” another subjective assessment.
 
Today's example is based on an article from the October 17, 2010 edition of the St. Petersburg Times. It was written by N. Gregory Mankiw who is a professor of economics at Harvard and who has worked in government positions in the past. Given his profession, I am assuming that the numbers and analyses he discusses in his article are quite accurate and valid.

 The basis of his reasoning in the article is the fact that he earns over $250,000 a year based on his various income earning activities and would have seen his top Federal tax bracket rise from 35% to 39.6% if President Obama had gotten his way and raised the tax rates for people like him. By his own admission, Mr. Mankiw is living comfortably within his earning potential. However, his one primary desire, like many parents, is to leave some wealth and money behind for his kids.

 His hypothesis is what would he do if someone offered him $1,000 increment income to write an article, based on his knowledge, background, and expertise. In a utopian world, where there is no taxes, he would be able to take that $1,000 put it in an investment earning 8% a year and within 30 years, he would have a $10,000 legacy he could pass onto his children. Nice thought, noble family thing to do.


- Although the market values his expertise at $1,000, he does not end up with that much. In fact, according to his calculations, after you figure in Obama’s higher tax rates for him, increased Medicare taxes because of Obama Care, state income taxes, existing Federal income tax rates, etc., that $1,000 quickly becomes $523.

- In addition, he no longer can get that 8% investment return he desires. Why? Because the company he invests in, that would have been able to provide that kind of return, has to pay taxes on their earnings, taxes that cannot be passed onto the shareholders. In addition, as an investor he has to pay taxes on any dividends or capital gains his $523 returns, so that this round of taxes reduces his potential 8% return to only 4%.

 - Over 30 years at only 4%, his initial $1,000 action does not get him the desired $10,000 for his kids but only $1,700.

 - However, the political class is not done yet. When Mr. Mankiw dies, his estate will also get hit with an estate tax before the money can pass to his kids. Thus, according to his calculation, after the estate tax is done, his kids are left with only about $1,000 to inherit.

Thus, under the existing tax plans in the country and Obama’s plans to increase taxes, both income and Medicare taxes, his $1,000 effort, once invested, really grows to …$1,000 after 30 years. He estimates that if Obama’s did not get his increased taxes, income tax and Medicare tax, he would be able to leave $2,000 to his kids, still a paltry return after 30 years of investment. In fact, he calculates that his marginal tax rate is actually 90%, not 39.6% that Obama wants it to be. His conclusion: why should he knock himself out for incremental wealth when the government will strip it away from him in taxes?

 He is quick to point out that most people couldn’t care less whether or not he took on the $1,000 job and he would be right. However, he also points out what would happen if others in the economy did the same thing he did:

 - What if your favorite movie star stopped making pictures because the incremental work was no longer worth the extra effort, given the increased tax situation?

 - What if your favorite recording star stopped doing concerts because the incremental work was not worth the extra effort, given the increase tax situation?

 - What if a top cardiac surgeon stopped doing incremental work because it was not worth the extra effort, given the increase tax situation, and you had a heart problem?

 - What if a top cancer specialist stopped doing incremental work because it was not worth the extra effort, given the increased tax situation, and you had a cancer condition?

- What if a top philanthropist stopped earning money that would go to his charities because it was not worth the extra effort, given the increased tax situation, and you needed that output from his charities?

You get the point. A society starts to mummify and stagnate when members of that economy decide it is better to do nothing, because of the tax burden, than to exert one’s self, leveraging one’s skills, expertise, or compassion to make the world and the lives of others better and richer. The world and yourself is worse off if a favorite actor, favorite recording star, best doctors, best charity providers, and yes, best economists, do not share their abilities and insights with the rest of us because the tax burden is not worth the effort.

Trade off these societal losses with what the American class has done with our taxes lately:

 - The Federal government admits that it loses upwards of $100 billion of taxpayer wealth every year through fraud and mismanagement of its Medicare, Medicaid, Social Security, and income tax processes.

- The Federal government spends more on defense than every other nation in the world combined, possibly because of the hundreds of billions of dollars it wastes every year through fraud and mismanagement, development of unnecessary weapons systems, costly and unnecessary foreign deployment of U.S. troops overseas, etc.

- The Federal government supports dozens, if not hundreds, of unnecessary corporate welfare programs, from the inane multi-billion dollar annual subsidies of corn ethanol production to the promotion of U.S. cranberry juice overseas.

- The Federal government supports thousands of unnecessary local entertainment programs such as the annual Nevada Cowboy Poetry contest, programs that should be supported by themselves or local interests, not by Washington D.C. and taxpayers that do not care about Nevada, cowboys, or poetry.

- The Federal government operates dozens of redundant programs across a multitude of government entities, a redundancy in effort, staffing, and expense, a redundancy that wastes billions of dollars a year but produces very little tangible results and benefits.

 We do not have enough years to list out all of the wasteful spending and inefficiencies of the Federal government and the political class that runs it. In return for all of this waste, we face the potential of losing the wonders, joys, and services that talented people could provide us if their efforts were not suppressed by higher and higher tax burdens. When that happens, no Cowboy poem is worth it, no matter how good it is. Rather than debating what the tax rates should be for the high earners in the economy, maybe we should be debating and executing some of the steps from “Love My Country, Loathe My Government” to get the outrageous, existing government spending under control before the politicians throw more wealth down the drain.

 Are our tax laws fair? That is for each person to subjectively decide. And to also decide whether poetry contests outweigh the suppression of individual initiative. But Mr. Mankiw provides a real life example of the reality of raising taxes and that reality is not a positive one if it negatively affects your entertainment, your health, or your understanding of economics.



Our book, "Love My Country, Loathe My Government - Fifty First Steps To Restoring Our Freedom And Destroying The American Political Class" is now available at http://www.loathemygovernment.com/. It is also available online at Amazon and Barnes and Noble. Please pass our message of freedom onward. Let your friends and family know about our websites and blogs, ask your library to carry the book, and respect
freedom for both yourselves and others everyday.


Please visit the following sites for freedom:

http://www.cato.org/
http://www.robertringer.com/
http://realpolichick.blogspot.com/
http://www.flipcongress2010.com/
http://www.reason.com/
http://www.repealamendment.com/However, we do not live in a utopian world without taxes and that is where the problems start, as does Mr. Mankiw’s math: