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What the Left Doesn’t Understand About Taxes

As the Democratic party moves further to the left and the Republican party moves further to the right, not only will the polarization that we have been witness to increase, we may begin to see ruptures on policy issues that in the past were nothing more than policy disagreements. Take the issue of taxes as an example.

Taxes have always been a hot button issue, with Democrats and/or liberals supporting higher taxes to finance more programs and Republicans and/or conservatives supporting lower taxes as but one means by which government could be kept small. Therefore, it would not be completely wrong to characterize the tax debate as reflective of the larger issue concerning the size of the government.

If big government means more spending on programs, then taxes will have to be higher. And if small government means less spending on programs and fewer regulation, then taxes can be lower because less money is needed for programs and bureaucracies to regulate. Indeed, one version of the median voter theorem holds that it is the median voter who determines the size of government.

In the median voter model developed by Alan Meltzer and Scott Richard the early 1980s, the greater the distance between the median voter’s income and average income of society, the higher the level of inequality there is. The more inequality there is, it is more likely that redistribution will be sought as the remedy for increased inequality. Redistribution through higher taxes means bigger government. Therefore, the median voter is effectively choosing the size of government by choosing the tax rate.

In the current political climate, taxes are more ideological. The debate over taxes, especially from the left, is framed as a matter of the haves paying their “fair share,” which is really a euphemism for the haves owing something to the have-nots. The right continues to argue against taxes on the grounds that it is inefficient and an infringement of personal liberty. In response to the left they not only point out that the top ten percent pays close to 70 percent of the nation taxes, but they assert that the left merely wants to punish high earners for their success.

Now we can return to our contenders for the 2020 Democratic party nomination for president. They are all promising Medicare for all and free college. All of this costs more money and the only way to pay for it is to have a massive tax increase. In short, they are letting the voters know up front that if elected taxes will increase, and that the rates will be higher for those at the top of the distribution. Elizabeth Warren has already announced her idea for a wealth tax of 2 percent on family assets in excess of $50 million.

In principle, this does not sound too bad given that it would only affect 75,000 families who constitute the .01 of the distribution but hold ten percent of the nation’s wealth. And yet, the ultra-wealthy with their army of accountants and attorneys would no doubt find ways to move their wealth in excess of $50 million offshore and avoid paying the tax.

The wealthy always avoid paying higher taxes, and historically have. Even when Meltzer and Richard put forth their version of the median voter theorem on the assumption that more taxes would be paid to finance redistribution, it was before the major Reagan tax reform of 1986 which reduced the top tax rate from 50 percent to 28 percent. This reform resulted in just two rates: 15 percent and 28 percent and the elimination of a host of deductions and loopholes which often resulted in the wealthy not having to ever pay 50 percent.

Prior to this reform, the wealthy had greater ability, built into the tax code, of course, to avoid paying taxes. Therefore, as a theoretical construct one can talk about the median voter choosing higher tax rates for others, but the reality was that the effective taxes those others were going to pay were going to be considerably less.

What, then, does this mean? Any political compromise that is reached to agree on new higher marginal tax rates to pay for more spending will include a new set of deductions which those with money will best be able to take advantage of. Consequently, those who are being targeted to pay more most likely will not, although by the tax rate on paper they will be. This means that the burden will fall on the middle class.

Although it has become fashionable in some cases for policymakers, especially politicians opposed to minimum wage increases to defer to economists, all economics can tell us is how individuals and/or firms behave in response to certain stimuli. Most economists would agree that tax codes should be about generating government revenue; not about social engineering. Therefore, the lower the tax, even if that means eliminating all deductions, the better.

It would do politicians, especially those on the left, to study the Laffer, which illustrates the theoretical relationship between rates of taxation and governmental revenue. If one pictures a bell like structure with two tails on either end, at the first tail where there is zero taxation there is zero revenue, and at the second tail where there is 100 percent taxation there is also zero revenue.

This is because there will be no incentive to work and/or invest if 100 percent of one’s income is taxed. Even if a 100 percent tax rate is an extreme, one can see that at some point on the curve as marginal tax rates increase, revenues decrease because workers decide to supply fewer hours of their work to the labor market.

The point of the Laffer curve was to illustrate that a lower tax rate — perhaps 35 percent — was the point at which more revenue would be generated. Therefore, even an increase in the marginal tax rate by 5 percent would result in less revenue, with higher tax rates on the wealthy resulting in  even less.

Critics, of course, will point out that the Laffer curve was discredited with the Reagan administration that used it to justify massive tax cuts along with huge increases in defense spending. Well not so fast. Remember all economists do is explain behavior. At the time, Reagan argued that the additional revenue from tax cuts would be enough to spend more on the military and reduce the deficit. Of course, the deficit increased because the increased spending surpassed whatever increased revenue there might have been.

Again, the point of the Laffer curve is to figure out what the right tax rate is. Laffer never said you could do it all. Still, tradeoffs exist and choices need to be made. And yet, the new litmus test of Progressive ideology doesn’t allow for serious tradeoffs in policymaking. We see this in that there is no room for a moderate Democrat to ask 1) how we will pay for this agenda and 2) what the impact of greater taxes will be on the economy. That is why any future discussion of taxes will not only be more polarizing than in the past, it may be the beginning of a serious rupture in American politics.      

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