Higher Tax Rates on The Wealthy Would Reduce Tax Revenues


In the midst of persistent economic hardships and unsustainable public deficits, the Obama administration’s proposal for wealthier Americans to pay a ‘fair share’ of taxes to ease fiscal and economic difficulties is widely popular, but raising tax rates on upper incomes will be counterproductive and make things worse. How do we know this would be so? First, Europe tried it.

Despite having lower statutory tax rates on the wealthy than most European countries, the U.S tax system is more progressive and more effective in raising revenues from the wealthy than most European systems. Don’t believe it? Whatever our opinions or political views, the data tell us this in several different ways.

The Organization for Economic Cooperation and Development (OECD), a nonpartisan organization comprised of the world’s most advanced and successful economies, calculates income inequality before and after taxes. By this measure, the U.S. tax system is even more progressive than those in European welfare states. Despite higher tax rates on the wealthy in Europe, actual taxes paid by the wealthy as a share of their total income are lower in Europe than in the U.S.

But wait a minute, we ask: how do higher tax rates on taxable income result in lower revenues?

With very high tax rates, taxable income and tax revenues tend to decline, both absolutely and as a share of total income. Individual responses to higher tax rates, wealthy, middle class or poor are limited only by the expansive boundaries of human creativity and imagination and by the extent of our tolerance for ever more intrusive government restrictions on individual choice. Examples of likely responses are well understood and demonstrated: for example, less incentive for entrepreneurs to introduce the innovations or take the risks that can help to expand employment opportunities and incomes for everyone, and increased incentives to minimize income subject to taxes. Again, the list of possible responses is endless, but we can easily see their effects by comparing the share of taxes paid by the wealthiest taxpayers to the share of total income they receive.

In the U.S., the richest ten percent pay a higher share of taxes relative to their income than in Sweden, France, Germany, Britain, or Japan, and this share became even higher after the Bushera tax cuts, which increased the actual share of taxes paid by the wealthiest Americans relative to their share of income. Indeed, in terms of actual tax revenues, either in absolute or relative terms; it is more accurate, if less politically popular, to say that the Bush-era cuts were tax hikes for the rich rather than tax cuts.

Taxpayers at any income level are not robots programmed by IRS accountants, so statutory tax rates are not the same as realized tax ratios because we all tend to change our behavior in one way or another in response to changes in tax rates.

An increase in statutory tax rates can, and has, decreased revenues, both absolutely and as a share of income.

The U. S. faces real issues that contribute to our distressingly high level of income inequality, but overall, our tax system is not one of them. Indeed, It is just the reverse. Incomes are more equal after taxes than before, and the improvement in equality after taxes is greater in the U.S. than in the ‘fair’ tax systems of European welfare states that some in our country urge us to emulate.

If our priorities are to grow our economy, increase revenues from our wealthiest citizens, and ease the relative tax burdens of the poor and middle class, we will not view the likely results of higher tax rates on the wealthy as either fair or effective in solving our problems. Broadening the base of taxation while maintaining or even lowering tax rates is much more likely to be effective in both stimulating growth and raising tax revenues.

Joe Stone is W.E. Miner Professor of economics at the University of Oregon and former senior economist for international trade policy on President Reagan’s White House Council of Economic Advisers. Any opinion expressed is his own, not necessarily that of the University of Oregon.  



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