Taps Coogan – September 4th, 2020

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These days we hear a lot about the various schemes to raise taxes on the ‘Top 1%’ in order to plug massive deficits and fund new government spending programs. Yet, very rarely is there any discussion of how much money can actually be raised by taxing the 1%.

So, let’s do a simple thought experiment. How much tax revenue could we raise if we taxed every single penny of personal income from any source that qualifies as being in the ‘Top 1%?’

Let’s do some back-of-the-envelope math.

There are roughly 128 million households in the US. To be in the top 1% of income earners, your household has to make at least $422,000 per year. The average 1% household makes about $1.32 million a year.

Let’s image that you apply a 100% marginal tax rate on any income that qualifies as the ‘Top 1%.’ In other words, every penny of income above $422,000 per household gets taxed at 100%, regardless of whether it’s earned income, long term capital gains, dividends, etc…

Since the average ‘1% household’ makes $1.32 million a year, in that scenario the average ‘1% household’ would pay an extra $601,660 in taxes per year (100% of income between $422,000 and the average of $1.32 million in income, minus the 37% top marginal rate they were already paying on that income).

Overall, that would raise roughly $724 billion dollars. Now, if that seems like a lot of money, it’s not. The national debt rose by roughly $1.3 trillion in 2018, and again by roughly $1.3 trillion in 2019, and that was during the ‘good times’ when tax revenues were rising, the economy was growing, and unemployment was at historically low levels. This year the deficit is likely to be somewhere between $4 and $5 trillion and will likely remain in the multi-trillion dollar range for the foreseeable future. No one knows how much spending plans like the ‘Green New Deal’ would cost (because it’s science fiction), but it’s estimated at $50 to $93 trillion in just ten years.

Reality Check

In reality, if a 100% marginal tax rate was applied to income over $422,000 it would raise roughly zero dollars in revenue. No rational person or company would pay someone one penny more than $422,000 if the tax rate was 100%, or 90%, or 80% for that matter. No investor would buy or sell one share of stock if doing so meant they lost 100% of the income. How would you pay your state taxes? What would actually happen is that tax revenues would go down dramatically as wealthy people would simply leave.

But if you could, somehow, extract every penny of income that defines the top 1% of Americans, it wouldn’t balance the budget deficit of a few years ago let alone the deficits in our post-Covid world.

Taxes Are Already High

The little known secret is that combined federal, state, and local income taxes for high earners in the US are already among the highest in the developed world, and that was before State and Local tax deductability ended. It is the same story for corporate taxes. The recent corporate tax cut brought the US from literally the highest corporate tax rate in the developed world to roughly average.

If you are wondering how European countries like France and Denmark fund their vast entitlement programs, it isn’t just on the back of the rich. They have very high sales and value added taxes (25% in Denmark) and very high payroll taxes. The burden of those taxes falls on average people much more so than on the rich.

Why are these European countries placing such a large a tax burden on the middle class through labor and sales taxes (VAT taxes)? Despite what you’ve been told, there just aren’t enough rich people to tax, and when you tax them too heavily, they leave. That has been doubly true of punitive wealth taxes which have generated vanishingly little revenue (0.07% of GDP in Finland and 0.2% in France), led to massive wealth emigration, and have mostly been abandoned or reduced wherever they’ve been tried. Eight of the 12 European nations that tried wealth taxes have abandoned them completely.

The Actual Problem

No combination of tax hikes on the rich is going to come close to balancing the US budget deficit in the coming years, to say nothing of funding pie-in-the-sky spending policies. If America adopts pie-in-the-sky policies, middle class Americans will end up paying for them. You will end up paying for them.

By no means is the US tax system well designed. Sweeping tax reform is badly needed. But let’s be completely honest, ‘soak the rich’ punitive taxes aren’t going to balance the budget, let alone fund new spending. In the long run, they probably won’t even raise tax revenues; they’ll just cause capital flight.

The solution to the wealth divide problem lies with addressing its actual causes: endless accommodative monetary policy that incentivizes financial engineering, rewards financial asset holders, punishes middle and lower classes savers, and encourages ‘winner take all’ effects. The solution lies with ending trade, economic, and regulatory policies that have incentivized offshoring, crushed small businesses, and reduced the success rate for start ups.

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