One of the great unlearned lessons of public policy is that tax increases never bring in anywhere near the revenue that was anticipated. A 5 percent tax increase never nets 5 percent more revenue for the government, for two major reasons: high taxes depress economic activity, resulting in a smaller pie for the State to cut itself a big slice of; and people take steps to avoid paying the taxes.
Both of these factors become far more pronounced as tax rates rise. That’s one of the essential insights of economist Arthur Laffer’s famed “Laffer Curve.” When tax rates are low, they don’t hinder economic growth very much, and evading them is more trouble than it’s worth. Also, systems with low tax rates tend to be fairly simple – they aren’t encrusted with the barnacles of tax deductions, worked out in collusion with politically influential special interests, or created to impose the ideological preferences of the State upon its citizens.
Low, simple taxes are far more likely to bring in something close to the anticipated revenue; complex systems with high rates and lots of deductions give taxpayers both means and motive to practice evasion strategies. (And no, “millionaire surtaxes” like the “Buffett Rule” don’t “solve” this problem, as Warren Buffett could explain in detail, if you shot him full of sodium pentothal.)
How does one go about “avoiding” taxes? We’re not talking about illegal tax evasion here, although that could be viewed as a form of extreme tax avoidance, and its incidence naturally becomes higher as the benefits of illegally evading soaring tax rates outweigh the perceived costs of detection and punishment. There are always legal ways to avoid taxation. They generally involve changing behavior to minimize tax exposure, by sheltering income and collecting deductions.
These options tend to be more readily available to high income earners. They can afford to pay skilled accountants, and they have more realistic choices for restructuring income to avoid high taxes, especially high marginal taxes. If another $1000 of income would trigger a confiscatory tax rate, they can just pass up on earning that $1000. Many of these strategies injure the economy, because they involve avoiding productive, job-creating investments in favor of sheltering income.
Such options are not practical for lower income earners, who get almost all of their money through direct compensation for employment, and tend to have fewer deductions they can “chase” just to reduce tax exposure. Not many middle-class people buy a house just because the mortgage interest is deductible.
For these reasons, high marginal rates on top income earners – in other words, the kind of “soak the rich” strategy beloved of President Barack Obama – are pure snake oil. They don’t work, not nearly as well as socialists always promise they will. That’s one reason soak-the-rich promises are always a mere prelude to the real government cash grab: big tax increases on the middle class. Collectively, that’s where all the money is, and it’s divided between a large number of people who have limited options for avoiding the tax increase. Rhetoric about making the rich “pay their fair share” is strong whiskey fed to easily manipulated middle-class voters, to numb them up for the serious tax bite headed their way. Of course, these middle-class taxes will be portrayed as sadly, regrettably necessary – something the socialists do with a heavy heart, because the Evil Rich just never seem to “pay their fair share,” and now a tidal wave of bills from years of wild deficit spending have come due.
At the most extreme level, a high income earner faced with confiscatory taxation can do something no middle-class person can do: he can leave the country. Sometimes this is merely a matter of moving assets overseas to escape the grasp of the socialist, but other times the wealthy revenue target follows his assets in the flesh. And that’s exactly what just happened in Britain, as the National Center for Policy Analysis reports:
In Britain, figures show that a 50 percent tax rate on the country’s top earners has resulted in less revenue for the government, says the Telegraph (U.K.).
In 2009, more than 16,000 people declared an annual income of more than £1 million.
However, since the 50 percent top rate was introduced before the 2010 election, only 6,000 people reported an annual income of more than £1 million.
This has cost the UK £7 billion in lost revenue.
Conservatives are using this as fodder against the Labour Party’s claim that a higher tax rate for the wealthy is necessary to increase government revenues. It is believed that many of the richest Britons either left the country or took steps to avoid paying the taxes. Moreover, entrepreneurs are deterred from coming to the country because of the tax rate.
This has led to a political struggle over the need to reduce those rates to win the millionaires back. The announcement of a 5 percent reduction in the top rates promptly resulted in a significant rise in the number of British millionaires willing to subject themselves to taxation. The Laffer Curve has rarely been so clearly visible.
But of course, the U.K. has a lavish, bankrupt welfare state to pay for, and its dependents aren’t about to entertain the notion of benefit cuts, no matter how severe the fiscal crisis becomes. They’ll express their displeasure loudly, through demonstrations, riots, and ultimately violence, the same way every dependent population behaves when the State runs out of money to buy their lollipops. The brutal calculus of socialism makes this inevitable. Meanwhile, the revenue targets of the Left will express their displeasure much more quietly, and effectively… by leaving. The same things will happen in America, not very long from now. Count on it.