Gouging the rich?

Robert Kuttner

April 23, 1993|By Robert Kuttner

CONSERVATIVE DEFENDERS of supply-side economics are now arguing that President Clinton's plan to raise taxes on the rich is not just unfair -- it's also futile. If you raise tax rates on the rich they will just spend less time earning income, and work harder at tax avoidance.

These people have no shame, and they assume we have no memory. This set of claims mirrors the supply-side predictions of the early 1980s that lower tax rates on the rich would yield increased revenues. And the latest arguments against taxing the rich are just about as accurate.

As you will recall, advocates of the 1981 Reagan tax cut predicted that a cut in tax rates would actually increase tax collections -- because rich people would supposedly work harder, invest more, and so on. Supposedly, the federal budget would be in surplus by 1984.

Instead, we got a decade of escalating deficits; indeed, the deficits would have been far worse but for the fact that payroll taxes were raised on working people. Supply-side economics was an intellectual fraud and a budgetary debacle.

One of those supply-side boosters was Harvard economist Martin Feldstein, who served as chairman of Reagan's Council of Economic Advisers. Today, in scholarly papers and op-ed columns, Mr. Feldstein is leading the charge against higher taxes on the rich, based on the same faulty logic.

The Clinton deficit-reduction plan would restore higher tax brackets on households with taxable incomes in excess of $140,000. They would pay at a marginal rate of 36 percent, up from 31 percent under present law (and down from 91 percent in the 1940s). Households with taxable incomes over $250,000 would pay an additional surcharge, for an effective top rate of 39.6 percent.

Mr. Feldstein contends that as much as 86 percent of revenue increases anticipated from higher tax rates on the rich would evaporate, for two reasons. First, rich people would stop working so hard; second, they would move more of their income into tax shelters.

In a paper for the National Bureau of Economic Research, co-authored with Daniel Feenberg, he wrote: "The most direct way for a taxpayer to reduce taxable income in response to substantially higher marginal tax rates would be by working less." Mr. Feldstein argues, hypothetically, that if a couple making $180,000 responds to the tax hike by working less hard and bringing in $9,000 less income, the Treasury would actually be worse off.

However, this projection is pure speculation. Most economists have long observed that actual people respond to tax increases in opposite ways. Some may decide to work less in order to avoid being pushed into higher tax brackets, while others will work harder to maintain their levels of after-tax earnings. Few people base their work effort mainly on changes in tax rates.

Two recent articles in the Journal of Economic Perspectives, summarizing research on how tax rates actually affect the way people work and earn, suggest that any "labor effects" of tax changes are far more modest than Mr. Feldstein claims, and in some cases the opposite of what he projects.

Mr. Feldstein's second argument at least has a grain of plausibility. If top tax rates go up, he contends, more wealthy taxpayers will try harder to shelter their income by changing how they invest and how they are compensated.

For example, wealthy people could shift their investments into tax shelters such as tax-exempt bonds, or take more of their pay in the form of fringe benefits and deferred compensation, or invest in stocks for growth rather than taxable income and hence defer being taxed.

However, since the 1986 Tax Reform Act, many of the most flagrant loopholes have been closed; it's not as easy to shelter income as it once was. Nor, except for high ranking executives, is it so easy to modify your pay package for tax-avoidance purposes. Nor can investors easily shift from, say, high-yield stocks to high-growth stocks without paying a capital gain.

And in fact, the Clinton Treasury did take into account the reasonable likelihood of increased tax-sheltering. The Treasury took its raw calculation of revenue increases from higher tax rates, and then reduced that number by 15 percent.

Ironically, one of the reasons why tax-sheltering is newly possible is that the Clinton program, in deference to investors, would leave the capital gains rate at 28 percent, while raising the top rate on wage and salary income to 39.6 percent. Robert McIntyre, the director of Citizens for Tax Justice, observes that if the critics are truly worried about revenue losses caused by wealthy people sheltering income, they should support a higher capital gains rate and work to close other loopholes.

Nothing should enrage the ordinary, workaday taxpayer more than the claim that it is futile to try taxing the rich. It recalls Leona Helmsley's arrogant comment that taxes are for the "little people."

Even with the system's remaining loopholes, higher tax rates on well-off people really will yield higher revenue collections if Congress doesn't lose its nerve. Think about it: If tax avoidance by the rich were so easy, nobody would be railing against the higher rates.

Robert Kuttner writes a regular column on economic issues.

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