Tax Cuts For the Rich!

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Renowned economist takes on the issue:

'Tax cuts for the rich!'
Thomas Sowell

October 22, 2004

With the election season coming into the home stretch, the cry of "Tax cuts for the rich!" is ringing out across the land from Democrats desperate to regain power in Washington. Like many other political slogans, its popularity depends on slippery words and sloppy thinking.

First of all, just what does "rich" mean? And does it have any relevance to the kinds of tax cuts at issue?

The recent release of some of Teresa Heinz Kerry's tax records reveals as much about the confusion over this issue as it does about her financial situation. The Kerrys are clearly rich, with several homes, a private jet, and millions of dollars in annual income. Yet they paid just 13 percent of their income in taxes.

That's less than most American pay -- and it is not due to "tax cuts for the rich." It is due to putting much of their wealth into tax-free municipal bonds or other tax-exempt securities. So whether income tax rates are high or low, on rich or poor, makes little difference to them.

One of the major purposes of tax cuts is to get people to take their money out of tax-free securities and invest that money in something that will increase economic activity and create jobs. Since our income tax system is steeply graduated, any across-the-board tax cut will immediately benefit most those who pay most of the taxes -- which is to say, people with higher incomes.

After Ronald Reagan's tax rate cuts in the 1980s first brought out anguished cries of "tax cuts for the rich," it turned out that the federal government collected more tax revenue than ever and that people in upper income brackets not only paid a larger amount of taxes than before, but even paid a higher share of all taxes than before.

How could this be?

This takes us back to slippery words and sloppy thinking. What was cut were tax rates. What went up were tax revenues. At lower tax rates, it paid to take money out of tax shelters and put it somewhere where it was more productive, both for the individual investor and for the economy as a whole.

As the economy expanded and incomes and employment rose, tax revenues rose, despite lower rates being charged for a given income. The incomes of people in the higher brackets went up especially sharply, so the total taxes they paid also went up especially sharply -- again, despite lower tax rates.

Much sloppy thinking about economic issues is based on reasoning as if there is a fixed amount of income, so that someone has to lose whenever someone else gains. The real test of an economic policy is whether it can produce a rising tide that lifts all boats.

Ronald Reagan's policies did that, even while he was being denounced for "tax cuts for the rich."

There is also a lot of sloppy thinking about what "rich" means. Income is not wealth and income taxes do not apply to wealth.

People who have high incomes without much wealth are not rich. If they lose their jobs tomorrow, they are up the creek if they cannot find another job that pays as well. But these are the people who get hit with high income tax rates, often paying far higher rates than genuinely rich people.

High-tax liberals like John Kerry seldom define what they mean by "rich." When they do, it is almost always expressed in terms of income, not wealth.

The income of most Americans varies greatly over the course of their lives. Most of the people who are in the bottom 20 percent at one point are in the top 20 percent in later years.

A family income of $100,000 a year does not make you rich. A couple earning $50,000 each probably did not start out making $50,000 each. People usually work up to their peak income after many years of effort and struggle -- and they may not be that far from retirement time, when they will have to give up that income and live on their savings and pensions.

Most Americans are likely to become "rich" -- as defined by high-tax liberals -- at some point in their lives. So when liberal demagogues start talking about taxing "the rich," send not to know for whom the bell tolls. It tolls for thee.

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Sowell is a pretty good writer.

Here's one thing the looter demagogues just don't get. The REASON that Teresa Heinz Kerry only pays 12% tax is that she spends disproportinately more time and money engaged in aggressive tax avoidance than the average person.

Suppose John Heinz Kerry is elected, and upon assuming the office, determines that his first priority is to balance the budget by rolling back the tax cut. Do you know what people will do?

1) "Disintermediation" into tax-advantaged investments. This means, no more putting your money into small-cap growth stocks, it means you put it into things like Triple-tax-free municipal bonds.

2) Due to the "Supremacy Clause" of the US Constitution, muni bonds are generally exempt from federal taxes. And if you're in a state like Florida, which has no state or local income taxes, that means your overall tax burden goes WAY down.

3) Yes, Munis don't yield nearly the same as a taxable fixed income security, like a Corporate bond. But the math is simple, you can figure out the equivalent yield based on the tax bracket you're in. And guess what, if your marginal rate goes up, the tax-equivalent yield just got a whole lot better.

Does anyone see what the critical difference is? Money shifts into tax-advantaged investments to wait JHK out. And who loses?

The entrepreneur, who depends on the availability of capital to grow her business. The domestic manufacturer, who needs low tax rates to encourage investment here. The consumer, who, contrary to the Kerry rhetoric, actually ends up shouldering a portion of the tax burden, and who bears the economic consequences in lost income due to reduced productivity and higher cost of capital.

By the way, who do you think buys the Chinese-made ceiling fans? Who do you think shops at WMT, which as a single entity is responsible for 10% of our foreign trade with the PRC? Does Teresa Heinz Kerry buy her clothing at Wal-Mart, Ladies and Gentlemen?

The great irony is that much of the articulation of the idea "Capital takes the path of least resistance" was put forth by none other than Ol' Vladimir Ilyich Lenin himself, in Imperialism, The Highest Stage of Capitalism. One would think he would have been included in the ideological Canon favored by those who put words in Kerry's mouth.