The Myth That Taxing Rich People Is Bad for the Economy

DavidGrace
Mar 27 · 6 min read
Image by sinzicraciun0 from Pixabay

So-called “trickle-down” economics, the idea that making rich people richer disproportionately benefits the middle & working class, isn’t true.

By David Grace (www.DavidGraceAuthor.com)

For forty years Republicans have been falsely claiming that lowering taxes on rich people and massive corporations creates a disproportionate benefit for the rest of the population.

Their converse false claim is that higher taxes on very wealthy people hurt the people in the middle and on the bottom of the economy.

The Myth That Richer Rich People Disproportionately Create Wealth For Poor People

The flawed argument for lower taxes for rich people is that more money in the pockets of rich people will be used to fund businesses which in turn generate jobs while poor people waste any additional income they get on the consumption of more goods and services.

To evaluate this claim, let’s ask ourselves: What do rich people do with their excess income over and above their expenses of living?

Stocks

When they buy stock in Google they aren’t buying it from Google itself. Google doesn’t get a penny of that money. Almost all of the money rich people spend on stocks goes to other rich people who are selling those same shares. The buyers are simply putting money into other existing stockholders’ pockets.

Except for Initial Public Offerings, all stock purchases are simply transfers of money between private parties and they generate no business capital.

Real Estate

Similarly, almost all real estate purchased by rich people is for already existing property. The purchase price just goes into the pocket of the previous owner.

Luxury Items

Yachts, luxury cars, jewelry, fine art, lavish vacations, summer homes, etc. do not generate jobs for the average American.

Capital Investment

Sure, to the extent that rich people buy stock at an IPO or participate in a venture capital fund they provide capital for new businesses, but those investments constitute only a fraction of the top 5%’s money. Rich people diversify their holdings with actual capital-formation investments constituting only a fraction of their total wealth.

If you break down the assets of very wealthy people, probably less than 10%-15% of the total consists of stock purchased at an IPO, an investment in a VC fund, or a savings or other cash bank account. That means that a 10% reduction in their income would at most translate to a 1.5% reduction in new investment capital.

Our economy is awash in investment capital. American corporations have so much money that they were able to park over $3.1 Trillion dollars in foreign bank accounts in order to dodge U.S. taxes. A reduction of a percent or two in new private investment capital is nothing.

The truth is that instead of being used to create new businesses, almost all of very rich people’s additional income is used to buy things that already exist from other already rich people.

Real-World Numbers Show Cutting Taxes For The Rich Does Not Help The Middle Class

This chart of inflation-adjusted income between 1967 and 2014 for each 20% of the population makes it clear that during this period of tax cuts for the rich and maintenance of tax loopholes for huge corporations, the income for the top 20% approximately doubled and while the income for the bottom 20% declined and the income for the middle 20% barely changed.

Real-world experience shows that cutting taxes for rich people and rich corporations only benefits rich people and rich corporations and no one else.

More Money To Ordinary Citizens Stimulates The Economy More

Instead of trading dollars with other rich people for the purchase and sale of stocks or real estate or the purchase of luxury vacations or foreign automobiles, increasing the wealth of ordinary citizens immediately pumps money directly into American businesses.

At least 40% of American households are living paycheck to paycheck with savings of less than $400.

An increase of $2,000, $3,000 or $4,000 per year in the household income of ordinary Americans would result in a similar increase in the sales of food, clothing, medical services, and other consumer items, all to the vast benefit of the companies at the core of the American economy.

In short, increasing the wealth of the bottom 50% of the American households would do more to stimulate the economy, add jobs, and increase the country’s overall wealth than an increase in the wealth of the top 5% by the same amount.

The Bracket Tax Rate Is Different From The Average Tax Rate

Lots of people get upset about a high upper-bracket tax rate because they don’t understand that progressive taxes don’t apply to a person’s entire income. They only apply to income above a certain level.

Put another way, the Bracket Tax Rate is different from the Actual Tax Rate. Here is a simplified example of what that means.

Suppose this was the tax table:

On the one hand, if you’re paid $20,000,000, a tax of $10,822,500 seems like a lot.

On the other hand, if your net, after-tax income is $176,490 per WEEK or $25,213 per DAY it’s difficult to see how your lifestyle will be impaired by this level of taxes.

Put differently, the median U.S. income is about $59,000 gross per year and under this tax table, after taxes, the net median income would be about $54,700 per year.

It’s difficult to feel sorry for a person whose DAILY after-tax income is close to half the YEARLY after-tax income of the people in the middle of the country’s earning curve.

At a net income of $25,213 per DAY, those people would not be hurt by this level of taxes.

But Let’s Not Have An Income Tax At All

This discussion about tax bracket rates assumes that we will continue to materially fund the government by taxing income.

I would argue that we should not have an income or a gift tax at all.

Why?

  • The very nature of an income tax forces us to deal with the idea of different tax rates. I think we should have a system where everyone pays taxes at the same rate.
  • Income taxes are paid first, before citizens’ important expenses like food, housing, and medical care are met.
  • I think that the government should be paid last, after all other expenses of living are taken care of.
  • Income taxes result in a complicated tax system.

I could go on listing the detriments from taxing income, but we all realize that an income tax system has many negatives.

I think everybody should be able to earn as much money as they can and spend it any way they like without any tax on income and without having to worry about what is or is not deductible.

Instead of taxing income, I think we should tax net wealth.

Specifically, I would levy an annual tax of 2.5% on net wealth over $50,000 but with the obligation to pay that tax today capped at 30% of your net income over $50,000. So, if your net wealth was $1,050,000 your tax would be $25,000. If your net income this year was $100,000 you would only have to pay $15,000 in taxes right now and the other $10,000 would become a lien on your assets at an interest rate equal to the T-bill rate.

So, any tax you owed, but didn’t have to pay because your net income was too low, wouldn’t actually be paid until some future date when the asset was sold or you died.

Each person would be able to go through life earning as much as they could, spending as much as they wanted, and enjoying life without having to pay a gigantic chunk of their income to the government.

Instead, they would pay a reasonable potion of their net-wealth tax from their current income and defer the balance of that tax until their death when they won’t care about it any more.

For a detailed discussion of this idea, see my column:

Replacing The Income Tax With A Different Tax System That Is Fairer, Simpler & Less Painful– Revisited

– David Grace (www.DavidGraceAuthor.com)

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