Raise Taxes on the Productive - Kill the Economy

I guess it's not that difficult to understand that if you take the profit from those that are most capable of earning it, it won't be long before everyone else is affected by the loss of this most productive segment of our society. They are the engine of the economy.

This article is to the point on how taxes on the 1% of our tax base can be disastrous - it's a little long but please stick with it as you will increase your knowledge of how our tax system works in our economy and how the socialists what to destroy it. It's called income redistribution. A favorite of the socialists and communists.

The Tax Threat to Prosperity
By ARTHUR B. LAFFER
January 25, 2008;

Page A15 WSJOver the past 30 years, the U.S. has seen large changes in income tax rates as well as other tax rates. And, as would be expected, the budgetary implications of these tax changes have once again become a hotly debated partisan issue.But missing from the discussion are the huge differences in how the top 1% of income earners respond to changes in tax rates versus, say, the bottom 75% or 80% of taxpayers -- the so-called middle class and lowest income groups.

The "rich" quite simply are not like the rest of us.From the standpoint of logic, the supply of their taxable income should be far more sensitive to changes in tax rates than the supply of taxable income of the middle class and poor. In the highest tax bracket, 100% of all taxpayers have the highest tax rate as their marginal tax rate. And it's the marginal tax rate that elicits supply-side responses.

Of course, if you look at a tax schedule, it's obvious that people with the highest taxable income also pay taxes in every other tax bracket. These lower tax rates are "inframarginal" and don't affect behavior. From the standpoint of the rich alone, a cut in these lower tax rates reduces tax revenues.

Some 99% of all taxpayers paid taxes at the 10% rate in 2005, for example. Yet only 25% of all taxpayers had 10% as their marginal tax rate. Thus a cut in the 10% tax rate would have a supply-side impact on a relatively small portion of all those who pay the 10% rate -- while for the rest who pay the 10% rate, a tax cut would result in a deadweight revenue loss.

On these grounds alone one should expect a greater supply-side response with a change in the highest tax rate than any other tax rate.In addition, low-income earners have a lot less flexibility to change the form, timing and location of their income -- and the avenues open to them to reduce their tax liabilities are far fewer. The avenues open to higher-income and highest-income earners include 401(k)s, IRAs, Keogh plans, itemized deductions, lifetime gifts, charitable gifts, all sorts of deferred income compensation plans, trusts, tax free bonds, etc.[Soaking the Rich]

Moreover, the culture surrounding low income earners is not nearly as focused on tax avoidance as it is in higher income earners; fewer lower-income earners, therefore, even avail themselves of the limited programs, laws and other opportunities to reduce their tax liabilities. This means that the supply of taxable income in the highest tax bracket should be far more responsive to incentives than it is in the lower tax brackets, all other things being equal.

Many tax-avoidance methods require expert advice and counsel from people such as tax accountants, lawyers, deferred compensation experts and, yes, even economists. Higher-income people find tax accountants and lawyers and other financial professionals far more cost-effective than do people with lower incomes, not only because the costs are spread over larger sums, but because the pursuit of tax avoidance is, dollar of income for dollar of income, more profitable at higher tax rates. This makes the taxable incomes of those who earn more, more variable, and the taxable incomes of those who earn less, less variable.

Academicians and politicians have finally come to understand that it's the after-tax rate of return that determines people's behavior. Even though statutory tax rates are far lower today than they were when, say, Kennedy or Reagan took office, it is still very true that for every dollar of static revenue change there is a much larger incentive affect in the highest tax bracket than in the lowest tax bracket.

But what actually happens to tax receipts by income tax bracket when tax rates change?Since 1980, statutory marginal tax rates have fallen dramatically. The highest marginal income tax rate in 1980 was 70%. Today it is 35%. In the year Ronald Reagan took office (1981) the top 1% of income earners paid 17.58% of all federal income taxes. Twenty-five years later, in 2005, the top 1% paid 39.38% of all income taxes.There are other ways of looking at tax receipts by income bracket. From 1981 to 2005, the income taxes paid by the top 1% rose to 2.96% of GDP, from 1.59% of GDP. There was also a huge absolute increase in real tax dollars paid by this group. In 1981, the total taxes paid in 2005 dollars by the top 1% of income earners was $94.84 billion. In 2005 it was $368.13 billion.

In 2000 this teeny, tiny group -- 1% of all taxpayers -- actually paid income taxes equal to 3.75% of GDP, which is why President Clinton had a budget surplus. Much of this huge surge in tax payments by the top 1% of tax filers resulted from the huge increase in realized capital gains resulting from President Clinton's capital gains tax rate cut to 20% from 28% in 1997.Let's take a look at the bottom 75% of taxpayers over this same time period -- the group current Democrats refer to as middle- and lower-income earners.

From 1981 through 2005, the share of all income taxes paid by the bottom 75% of all income earners (as reported on the individual income tax returns) declined to 14.01% from 27.71%. As a share of GDP, total taxes paid by the bottom 75% fell to 1.05% from 2.50%. The bottom 75% of all taxpayers today pay less than 35% of all the taxes paid by the top 1% of all income earners.

Over the last 25 years, the bottom 75% of all taxpayers' tax payments fell and their tax rates fell. This is the group the Democrats are targeting for tax cuts.The important point here is that, over the last 25-plus years, the only group that experienced an increase in income taxes paid as a share of GDP was the top 1% of income earners. Even the top 2%-5% of income earners saw a decline in the GDP share of their income taxes paid.

But now we get to the secret sauce, and the essence of what really happens in the realm of tax rates, incomes and tax payments by the rich.We have accurate data on both the total taxes paid by the top 1% of income earners, and on their comprehensive household income as measured by the Congressional Budget Office. From these two data series we can calculate the effective average tax rate for the top 1% of all income earners.

Surprise, surprise: The effective average tax rate for the top 1% of income earners barely wiggles as Congress changes tax codes after tax codes, and as the economy goes from boom to bust and back again (see chart).The question is, how can that effective average tax rate be so stable? The answer is simply that the very highest income earners are and have always been able to vary their reported income and thus control the amount of taxes they pay. Whether through tax shelters, deferrals, gifts, write-offs, cross income mobility or any of a number of other measures, the effective average tax rate barely budges. But this group's total tax payments are incredibly volatile.

For the low- and middle-income earners, the effective average tax rate has tumbled over the past 25 years, and so have tax revenues no matter how they're measured.Using recent data, in other words, it would appear on its face that the Democratic proposal to raise taxes on the upper-income earners, and lower taxes on the middle- and lower- income earners, will result in huge revenue losses on both accounts. But some academic advisers to Democratic candidates have a hard time understanding the obvious, devising outlandish theories as to why things are different now. Well they aren't!In the 1920s, the highest federal marginal income tax rate fell to 24% from 78%. Those people who earned over $100,000 had their share of total taxes paid rise -- from 29.9% in 1920 to 48.8% in 1925, and then to 62.2% in 1929. There was no inflation over this period.

With the Kennedy tax cuts of the 1960s, when the highest tax rate fell from to 70% from 91%, the story was the same. When you cut the highest tax rates on the highest-income earners, government gets more money from them, and when you cut tax rates on the middle and lower income earners, the government gets less money from them.Even these data grossly understate the total supply-side response. A cut in the highest tax rates will increase lots of other tax receipts. It will lower government spending as a consequence of a stronger economy with less unemployment and less welfare. It will have a material, positive impact on state and local governments. And these effects will only grow with time.

Mark my words: If the Democrats succeed in implementing their plan to tax the rich and cut taxes on the middle and lower income earners, this country will experience a fiscal crisis of serious proportions that will last for years and years until a new Harding, Kennedy or Reagan comes along.Trained economists know all of this is true, but they try to rebut the facts nonetheless because they believe it will curry favor with their political benefactors.

Mr. Laffer is president of Laffer Associates.