Monday, October 19, 2015

How Expensive is Raising Taxes on the 1%, Anyway? (Part 8 of 13)

(Note: This is the eighth of a series of posts dealing with Bernie Sanders's platform. For the first installment, go here)

I saw this posted on Twitter the other day, and I think it's worth taking a second look at, because it demonstrates a remarkable lack of understanding of Bernie Sanders's platform. Senator Sanders makes it very clear how we will pay for everything that he proposes, but understanding the nuance of this requires first that I disabuse you of a common misconception.

There are many in this country who decry government spending as if the government is incapable of doing anything well. But the critical issue of our times, as Robert Reich eloquently explains on a regular basis, is not how big government is. The critical issue of our times (and Bernie Sanders, more than any other Presidential candidate, understands this) is who government is working for. Whether we're talking about spending in the private sector or spending by the government, at the end of the day, everything that is spent in our economy counts as a cost for America. If Wal-Mart spends $1,000,000 improving the efficiency of the intersections near its stores, it has the same effect on our economy as if the state, local, or federal government spends $1,000,000 on an identical project.

So, with that in mind, how does America pay for Raising Taxes on the 1%, as described in the flyer pictured above? Let's take a look:

As a reminder, we're talking about the United States as a whole here, rather than just the federal government, so it's not an absurd question to ask how much it would cost to raise taxes on the wealthy. If increasing marginal tax rates on high incomes and capital gains reduces before-tax productivity, then it is possible that raising taxes could actually drain more money from the economy than it raises in federal revenues. In fact, basic economic theory would indicate that it does, because individuals will be (at least somewhat) less willing to earn additional income if they will see less of that income in their own pockets at the end of the day.

But the economy is much more complicated than basic economic theory would indicate, and basic economic theory is almost always incomplete when analyzing macroeconomic changes. There are three important factors to consider when evaluating the effect of a tax increase on the wealthy.

First, because the wealthiest individuals are also the most mobile, it is important to consider the possibility that very wealthy people, when faced with an increase in their effective tax rates, might move to another country to avoid taxes at home. This problem is especially problematic as the economy becomes more globalized, and we have seen examples of it in the corporate world, with companies like Apple and Burger King announcing the acquisition of foreign subsidiaries who would gather foreign profits to avoid the higher U.S. corporate tax rate. It stands to reason that if taxes increase on the richest of the rich, at least some of them would choose to relocate in order to reduce their taxes. The question is how many. According to a report in the National Tax Journal, an increase of nearly 3% in New Jersey's state income tax on people earning $500,000 or more annually resulted in a near-zero emigration rate. New Jersey's new "millionaire tax" was the highest state income tax rate in the country. The example of New Jersey is also borne out in Maryland and California, where similar policies were adopted. It stands to reason that migration out of New Jersey within the United States is easier than migration from the United States to another country, so if we saw no interstate exodus from a state policy, we would probably see no international exodus from a national policy. Clearly the super rich live where they live for reasons independent of their tax rates.

Second, the aforementioned reduction in the productivity of high-income earners as a response to increased tax rates is another factor to consider. Economists call this the Frisch elasticity of labor supply. The question has never been whether some high-income earners would work less if taxes were increased - really the question is how many and how much less? Harvard economist Gregory Mankiw threatened to work less back in 2010 if taxes were increased on people earning more than $250,000 a year, using some dodgy math to justify his position. In reality, though, a study from the Congressional Budget Office showed that this figure was very small, although it was higher for women than for men, and higher for people closer to retirement than younger people.

Finally, it is important to consider the potential benefit of increasing taxes on high-income earners. This benefit comes in the form of enhanced economic growth in the face of decreasing inequality. Increasing taxes on higher-income persons inevitably has a downward impact on inequality of incomes, by reducing the higher incomes (on an after tax basis) more than the lower incomes. According to a recent OECD study, increasing inequality reduced growth in Mexico and New Zealand by as much as 10% in the two decades leading up to the crash in 2008. If decreasing inequality improves economic growth, then progressive taxation will expand the economy, not diminish it, as long as the impact by reducing inequality exceeds the (very low) Frisch elasticity of labor and emigration rates. The reduction of inequality will partly be accomplished simply by increasing the tax burden, but it will also be affected by how the tax revenues are spent. If the spending enabled by the increased taxes lifts up incomes in below median households more than it does in above-median households, then it would have a greater impact in reducing inequality than the tax alone.

Now look, the point I'm trying to make here is that increasing taxes doesn't really have that much of an impact on the economy as a whole, and to the extent that it does, it appears to be a positive effect. Moreover, increasing taxes creates more funds that can be used to provide the services and programs that Bernie Sanders is proposing. What's more, the only periods of time in the last century when taxes on the highest income bracket have been lower than they were in 2008 were 1913-1916, 1925-1931, and 1988-1992. During that first window, real per capita GDP grew by an average of .75% annually, During the second window, real per capita GDP shrank by an average of 1.34% annually. During the third window, real per capita GDP grew by an average of .6% annually. For a comparison, between 1912 and 2000, real per capita GDP grew by an average of 6% annually. From 1950-1963, when the tax rate on the highest income bracket was at least 91%, real per capita GDP grew by an average of 9.15% annually. I'm not saying these high tax rates necessarily caused the high growth, nor that the low tax rates caused the low (negative) growth. What I am saying is that there is no evidence to suggest that the opposite is true.

At the end of the day, it isn't the size of government that we need to be worried about. We need to be worried about what the government is doing. And that's where we've been falling short. Bernie Sanders can help.

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