Canadian Investment Review

Why Taxing the Rich Won’t Help

Written by Scot Blythe on Tuesday, November 15th, 2011 at 4:17 pm

Protest Occupy Wall StreetThe Occupy movements have proven an inspiration – not least for data collectors. The raw data are not quite what they seem, at least for those looking for a simple, painless fix. Tax the rich may be  an evocative slogan, but it’s not terribly useful analysis.

To be sure, wealth is more concentrated and incomes are more polarized than since the 1920s. Is there anything public policy can do about that? Most millionaires receive their income in the form of wages and bonuses. Their compensation levels are governed by corporate boards of directors.
Wealth is harder to get a handle on, because it may be held in the form of shares or real estate or art. None has a stable value. If there is a tax-forced liquidation – or as we’ve seem from time to time, a market correction — the value of that wealth will likely be heavily discounted as too many distressed sellers seek too few willing buyers – unless the state steps in to stabilize wealth. Probably not what the occupiers were thinking.

So what does tax the rich mean? Equalize incomes? Or go where the money is? Equalize incomes sounds catchy, but not even Karl Marx believed in that. Some people will need more, and others less, to maintain a decent and equitable standard of living — not an equal one. Still, it’s an important point.

Arguably, the great equalizer since the 1920s has been the welfare state, in a twofold sense. The first is in making services such as education and health care available regardless of income. The second is in supplementing low incomes with transfer payments (unemployment insurance, state pensions, welfare, refundable tax credits).

Who pays for that? That would seem to be the real issue, given that Europe is in the throes of austerity and the curtain on that drama is about to be raised in the U.S.

Both the European and American middle classes claim to be tapped out. So tax the rich seems to mean “go where the money is.”This is where the wisdom of crowds turns into folly. Even if the 1% do pay more – which may not be such a bad idea – it won’t be enough to pay down deficits. That’s not an ethical judgment; it’s a mathematical one.

What does the data look like? In Canada, it is the middle class that has seen stagnant income growth, not the poor, writes Wilfred Laurier University economist Tammy Schirle in a cheeky blog called “’We are the 30%’ a better chant for protestors.” One observation from her data is that higher education rates have boosted income for women, and thus for many families — arguably a function of the welfare state. The analysis does not treat the tax-transfer system however. Still, as corroboration, Stats Can notes that the role of the tax-transfer system remains effectively unchanged; rising income disparities are not the consequence of social service cutbacks, but can be attributed, at least in part, to the rise of highly educated dual-income families.

It would appear the welfare state is working more or less as it should.

So who’s paying for it? According to another Stats Can study, the richest 10% paid 52.6% of federal income taxes, while their share of income was only 35.7%, as of 2002. Of course their income share had grown — perhaps because of their returns on education. The bottom 50% was paying 4.4%, a share that had declined by a third from 1990, even though their share of income had risen to 16.9% For the middle income group (“We are the 40%), their share of tax was  43%, though their share of income was  47.4%.

It seems the rich are paying more than their share. But, are they paying their fair share? As it turns out, the tax system is progressive, the Stats Can study notes. “In 2002, the 10% of taxpayers with the highest incomes paid an average of $16.47 for each $100 of income. On the other hand the one-half of taxpayers with the lowest incomes paid $2.89, a difference of $13.58. The group of intermediate-income earners fell between these two groups, paying on average $10.14 dollars for each $100 of income.” In fact, the 40% have seen their effective tax rate fall the most.

What may give readers pause is that the top 10% of the income distribution – the rich — starts at $64,500. Modestly well off, yes, but rich? Only compared to the median individual, with an income of $23,000.

But what about the 1%. Who are they? In Canada, the threshold is surprisingly low: $169,000, which accounts for 246,000 taxfilers, according to Armine Yalnizyan, at the Canadian Centre for Policy Alternatives. The income share of the top 10% she estimates at 42.5%; that of the top 1%, 15.7%

Their effective tax rates are roughly the same, around 30%, though the spread was much higher in the late 1940s: for the top 1%, rates were over 40%, while the top 10% paid around 25%.

Still, tax rates tell us little about the taxes that could be paid. In CCPA’s Alternative Budget, we do get an idea, however,. First, it estimates the cumulative cost of federal tax cuts since 2006 at $35.3 billion (just over one-third of which comes from GST reductions and an equivalent from broad-based personal income tax reductions). But the alternative budget does not suggest rolling back those tax cuts.Instead, it recommends a new tax bracket at 32% for those making $250,000 – most of the 1%. Expected yield is $2 billion. Then it adds a new tax bracket at the $750,000 level at 35%, yielding $1.2 billion. Sounds like a lot of money.

Except the total take from federal personal income taxes is $120 billion. So taxing the rich, while sexy in concept, is pretty much a wash in reality: a 2.5% solution for the 1%, and even more diluted against total federal revenues.

Is Canada a singular case where the rich are less than they seem? Not according to Adam Davidson, a reporter at National Public Radio in the U.S.

“It’s tempting to look to our millionaires and demand they pay more in taxes, but the same inconvenient truth applies. When you add up all the money made by all the people who earn more than $1 million a year, it amounts to around $700 billion. But since the millionaires already pay close to $200 billion in taxes, the government would have to increase rates to nearly 100 percent — which is about the worst idea ever — for it to have any real impact.”

What Davidson is referring to is a $400 billion annual gap between U.S. federal revenues and expenditures.

“It serves the interest of both parties to argue about taxes on corporations and the wealthy because neither wants to discuss the alternative, which is where things get touchy. To solve our debt problems, we have to go to where the money is — the middle class. People who earn between $30,000 and $200,000 a year make a total of around $5 trillion and pay less than 10 percent of that in taxes (owing mostly to tax incentives and the fact that most families make less than $68,000, where larger tax rates begin).  Increasing the middle-class tax burden an additional 8 percent, however, would actually have a bigger impact than taxing millionaires at 100 percent.”

To pare the deficit, the middle class – the 40-percenters — will have to pay because, to paraphrase bank robber Willie Sutton, that’s where the money is. Or is it the corporations? Watch for Part ll.

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