THE BOGUS CRUSADE AGAINST 'TAX CUTS FOR THE RICH'

Every Democratic contender for the 2004 presidential nomination has vowed to roll back -- in full or in part -- the tax rate reductions that were enacted as part of the Bush administration's effort to revive the US economy from the stupor that has afflicted it since the last full year of the Clinton administration. The candidates have stepped up their populist attacks on Bush's tax policy in recent weeks, even as evidence continues to mount that economic activity is finally beginning to awaken from its three-year slumber as the tax cuts gradually work their way into consumer and business behavior.

The populist campaign focuses on what the Democratic presidential hopefuls -- and most of the media -- invariably refer to as Bush's "tax cuts for the rich." In my view, this rhetoric is misdirected, misguided, misinformed, misleading, and mistaken. If the candidates' proposals to raise taxes back to punitive levels were to become a reality, the damage to the economy would be severe and long-lasting. And despite the demagogic oratory, it's the poor -- not the rich -- who would suffer the most if upper incomes are subjected to a higher marginal tax rate (the rate applied to the next dollar earned.) Viewed from either the demand side (business and consumer spending) or the supply side (productive effort), the proposed tax hikes threaten to derail the fragile recovery and send the economy sliding into long-term stagnation...

The Bogus Crusade Against 'Tax Cuts For The Rich': The Populist Prescription For Economic Stagnation - R. Bastiat

Every Democratic contender for the 2004 presidential nomination has vowed to roll back -- in full or in part -- the tax rate reductions that were enacted as part of the Bush administration's effort to revive the US economy from the stupor that has afflicted it since the last full year of the Clinton administration. The candidates have stepped up their populist attacks on Bush's tax policy in recent weeks, even as evidence continues to mount that economic activity is finally beginning to awaken from its three-year slumber as the tax cuts gradually work their way into consumer and business behavior.

The populist campaign focuses on what the Democratic presidential hopefuls -- and most of the media -- invariably refer to as Bush's "tax cuts for the rich." In my view, this rhetoric is misdirected, misguided, misinformed, misleading, and mistaken. If the candidates' proposals to raise taxes back to punitive levels were to become a reality, the damage to the economy would be severe and long-lasting. And despite the demagogic oratory, it's the poor -- not the rich -- who would suffer the most if upper incomes are subjected to a higher marginal tax rate (the rate applied to the next dollar earned.) Viewed from either the demand side (business and consumer spending) or the supply side (productive effort), the proposed tax hikes threaten to derail the fragile recovery and send the economy sliding into long-term stagnation.

The latest salvo was fired by Sen. Joseph Lieberman (D-CT), who has proposed a so-called "tax reform" that would actually include a further middle-class tax cut on top of Bush's across-the-board rate reductions in all income tax brackets. But along with it, not only would Lieberman reinstate the elevated Clinton-era tax rates levied on the incomes of upper-bracket taxpayers (39.6% + a phase-out of deductions), but he would impose a new 5% surtax on higher earnings. He would also repeal much of the tax relief on investment income that has spurred the revival of the stock market and business investment.

Despite Lieberman's reputation as the most "moderate" candidate for the Democratic presidential nomination, his plan is the most radically redistributionist among the candidates' tax proposals. In contrast, Gov. Howard Dean (D-VT) and Rep. Richard Gephardt (D-MO) are equal-opportunity tax raisers -- they would roll back the entirety of the President's tax cuts across the board at every income level -- while the other contenders would restore Clinton's confiscatory top-bracket tax rates but leave in place some of Bush's rate reductions in the lower- and middle-income brackets. Unlike Lieberman's plan, however, their current proposals would not further reduce middle class taxes or add a surtax on top of the rate increase for higher earners.

All of the soak-the-rich populist rhetoric accompanying these plans stirs the juices of the Democratic Party's anti-capitalist base -- the hot-blooded left-wing activists who vote in primaries and participate in caucuses. So it's not going to go away until one candidate locks up the nomination and -- inevitably -- moves toward the center in a bid to win over undecided voters in the general election. Nevertheless, the issue will stay alive because of the party's ideological antipathy to free-market outcomes and private property, its view of the tax system as a vehicle for drastic income redistribution, and its hard-core commitment to high levels of federal spending and high taxes to pay for it.

Apart from the dubious ethics of the whole idea of coercive government action to redistribute income (in this regard, I refer you to The Law, the classic 1850 pamphlet by my namesake Frédéric Bastiat), the populist recipe for the tax system is a witches' brew of deadly ingredients that would poison the US economy for years to come should it ever be shoved down the throats of American taxpayers. Inveighing against "tax cuts for the rich" may energize the true believers, but it is a phony crusade in every respect, based largely on confusion, fallacy, ideology, economic ignorance, and profound misconceptions. In particular, the populist campaign for higher marginal tax rates:

- fatally confuses the concepts of income and wealth, thereby aiming its fury at the wrong target and promoting policies destructive of both;

- looks only at the direction of change in tax rates, disregarding the more important effects of the actual level of tax rates on economic effort and productivity;

- focuses on how the economic pie is sliced, thus leading to advocacy of perverse incentives that would shrink the size of the pie and provide smaller slices for all who partake of it;

- fosters dependence for public revenues on the most volatile component of the tax base, tempting federal, state, and local legislative bodies to overspend in prosperity at levels that are unsustainable in adversity; and

- systematically disregards the economic impact and feedback effects of tax policy.

Income Versus Wealth

The careless use of the term "tax cuts for the rich" mistakenly implies that the income tax is somehow levied on "riches" -- i.e., accumulated wealth. But in fact, the income tax targets only the annual flow of income and output -- it leaves the current stock of wealth untouched. The fabled riches of Democratic Senators Kennedy, Rockefeller, and Corzine, among others, are safely sheltered from their party's populist crusade. Rather than punish the already-rich, the income tax penalizes -- and discourages -- the efforts to get rich that serve as a vital engine for progress and growth in a capitalist economy.

By definition, the income tax is levied not on wealth or assets but on the productive activity -- work, saving, investment, and risk-taking -- that generates income. High tax rates in the top income tax brackets disproportionately target, for example, small business owners who are not yet rich but are striving to get that way by innovating, investing their capital, raising funds, managing their enterprises, and risking their life savings,. Punitive taxes on upper incomes penalize the dynamic, successful individuals most responsible for creating new jobs in our economy and generating greater output and higher standards of living -- for the poor and middle class as well as the rich.

The more you tax something, the less you get of it, including productive activity. This is why many, if not most, economists regard the taxation of income as the worst possible way to raise public funds from the point of view of incentives. A top-heavy tax on industrious citizens risks slaughtering the golden goose by discouraging entrepreneurial activity, work effort, risk-taking, and job creation. It is a prescription for reducing the economic well-being of the entire society.

Marginal Tax Rates

By focusing on tax cuts and tax increases rather than actual levels of tax rates, the populist crusade raises the wrong question. From the point of view of fostering general prosperity, the relevant issue is not the direction of change but rather the appropriate level of the marginal tax rate that is most conducive to a high level of productive activity.

To an economist, the proper level of the tax rate is one that will maintain strong incentives to produce and still provide sufficient revenue to fund essential public services. If the tax rate is too high, then lower it. In the (highly unlikely) event that it's too low, then raise it. But to condemn a change in tax rates without reference to the prevailing level of rates is to assume without debate that some arbitrary tax rate structure -- current or recent -- should be maintained or restored without first examining how the level of marginal rates affects economic incentives.

As I argued in a previous commentary (see Iconoclast's historical series, Part Three, "The Damaging Legacy Of Clintonomics!" below on this page), the debilitating effects of President Clinton's marginal tax rate hikes were initially masked by the roaring recovery he inherited from his predecessor and the strong economic momentum built up during the Reagan boom of the 1980s. But by the time Clinton left office, the US economy was staggering under the full weight of the burdensome tax structure that was his principal economic legacy and, in my view, is a major reason for the sluggishness of the current recovery.

A Pie In The Face

Redistributing income through the tax system to even out the shares clearly serves as a disincentive to greater effort -- both to those whose incomes are taxed disproportionately and to the recipients of transfer payments. Apart from providing a safety net through public or private efforts, slicing the income pie according to egalitarian social and political criteria is likely to reduce productive activity and shrink the size of the pie, leaving everyone worse off -- with a smaller slice in terms of absolute size and a lower standard of living. An expanding pie feeds all faces, but a shrinking pie is not likely to assuage many appetites -- even those who get a larger relative share are likely to find that they actually get less to eat.

Incentives are powerful drivers of economic activity. How much you keep of what you earn motivates decisions to take risks, invest, innovate, and work. The more we tax and redistribute high earnings arising out of productive effort, the less we get of such effort -- thereby retarding economic growth, destroying jobs, and reducing prosperity at all levels of society. When high taxes cause the economic engine to sputter, poor families and marginal workers suffer the most -- even after taxes and transfer payments that are intended to even out the shares. As jobs disappear, it's the people with fewer employment prospects and without much cushion or reserve who pay the highest price when society over-indulges in the redistributive fantasies of the (mostly affluent) advocates of class warfare.

Unstable Tax Base

California Gov. Gray Davis's budget is the poster child for the folly of relying on a steeply progressive tax system to raise the bulk of government revenue. Davis took office in the late '90s during the dot-com boom, and as the tax revenue rolled in, it set up an irresistible temptation for the governor and legislators to expand entitlements and initiate new programs. California government spending ballooned by 40% in four years, and apparently nobody noticed that the revenue surge financing all that spending was coming largely from ephemeral windfalls such as stock options, capital gains, and other highly volatile, inflated, and unpredictable sources of personal income.

Many of these sources dried up after the energy crisis hit, the dot-com bubble burst, and the California economy headed south. But even as the high-income base melted away and tax revenues fell further and further behind expectations, the expanded state spending levels remained firmly in place. The California budget deficit rose to an astronomical 38 billion dollars, and high taxes and the worsening business climate drove hundreds of businesses and thousands of California's most productive workers to find refuge in Utah, Nevada, Colorado, and other states whose governments are more receptive to commercial and industrial activity. On October 7, 2003, the people of California voted in an unprecedented recall election to toss Davis out on his ear.

The populist proposals of the 2004 Democratic presidential candidates threaten to bring about a similar budget disaster at the national level. Thanks to the Clinton-era tax hikes, federal tax revenues are increasingly dependent upon the earnings of a small number of high-income taxpayers who derive much of their compensation from such volatile sources as year-end bonuses and various types of investment income.

When the US economy is healthy, revenue from these sources expands at a rate that is a multiple of the economic growth rate, and the windfall sorely tempts the government to ratchet up spending on domestic programs. But when the economy catches a cold, the high-income federal tax base comes down with pneumonia and wastes away much more rapidly than overall personal income. The greater the dependence of tax revenues on these volatile sources, the greater the shortfall of revenue in a recession and the larger the resulting deficit. To some extent, the process is self-reinforcing. Not only are earnings in the upper brackets highly variable, but the productive activity that generates them is easily deterred and discouraged -- precisely by the high tax rates designed to expropriate the fruits of the hard work, investment, and risk that brought it all about.

Economic Impact and Feedback Effects

The genius of the American economy lies in the opportunities it offers people to improve their circumstances -- and sometimes even to get filthy rich -- through their own effort and ideas. If a steeply progressive tax system reduces the payoff for such effort, then less of it will take place, to the detriment of economic growth, employment, and prosperity.

As noted above, the mislabeled crusade against "tax cuts for the rich" takes dead aim not at the idle rich but at the successful economic activities of society's most productive citizens. Raising their marginal tax rates weakens their incentive to work harder and undertake risk, innovation, saving, and investment. Higher taxes on productive activity will have feedback effects through the economic system, causing employment and output to be lower than otherwise would have been the case. The feedback effect for the government itself comes in the form of shrinking federal revenues and less income for politicians to redistribute to favored constituencies (not a bad outcome, considered in isolation). For the citizenry as a whole, however, the predictable result of higher marginal tax rates is reduced prosperity at every level of society.

Fortunately, feedback effects can occur through the political system as well. If politicians systematically rob Peter to pay Paul, they can count on Paul's vote -- but only until Peter stops accumulating taxable income and has nothing left for them to rob. Several million voters -- Peters and Pauls together -- sent that message to Gray Davis in early October, and the American electorate is likely to send it as well in 2004 to any presidential hopeful who wants to use the tax system to punish success and stifle economic opportunity.

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An EXCELLENT summation of the phony "tax cuts for the rich" line the Dems dredge up election year after election year...worthy of a full posting....

- ConservativeStLouisGuy

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