Taxing "The Rich:" Theory v. Practice

Stone Street Advisors's picture

This article is from Stone Street Advisors

In 2001, Peter Orszag and Joseph Stiglitz published a short paper wherein they concluded:

...if anything, tax increases on higher-income
families are the least damaging mechanism for closing state fiscal
deficits in the short run. Reductions in government spending on goods
and services, or reductions in transfer payments to lower-income
families, are likely to be more damaging to the economy in the short
run than tax increases focused on higher-income families.

This is all fine and dandy in the ivory tower (or the White House, as
it were to be less than a decade later), but in the realm of reality,
theories only get us so far, no matter how seemingly reasonable their
basis and underlying assumptions.

Today's WSJ included an essay about the state of The State of
California, specifically, its incredible reliance on the very-rich (top
1% +).  Many if not most commentators/politicians/etc seem to think that
taxing "the rich" at a (vastly) higher rate than everyone else -
especially "the poor" - not only makes perfect sense, but is more than
"fair," given the increasingly high % of income accruing to "the rich." 
This is all fine and dandy, except:

Nearly half of California's income taxes before the
recession came from the top 1% of earners: households that took in more
than $490,000 a year. High earners, it turns out, have especially
volatile incomes—their earnings fell by more than twice as much as the
rest of the population's during the recession. When they crashed, they
took California's finances down with them.

The problem with the "fair and equitable" approach is that populism
often ignores fundamental economic and financial reality.  In this case,
that many of those who make more than the magical ~$500,000 per year do
so not from a base-salary, but from bonuses and capital gains, neither
of which are very stable, let alone predictable with any real certainty.

The bigger problem is that it's not just California that's
significantly dependent upon income taxes from "the rich."  It's New
Jersey, New York, Connecticut, Vermont and Illinois, and to a lesser
extent, several other populous, economically important states as well.

State income taxes are generally less progressive than
federal income taxes, and more than a half-dozen states have no income
tax. Yet a number of states have recently hiked taxes on the top
earners to raise revenue during the recession. New York, for instance,
imposed a "millionaire's tax" in 2009 on those earning $500,000 or
more, although the tax is expected to expire at the end of 2011.
Connecticut's top income-tax rate has crept up to 6.5% from 4.5% in
2002, while Oregon raised the top tax rate to 11% from 9% for filers
with income of more than $500,000.

According to Orszag and Stiglitz, such tax increases for "the rich"
were a political and economic no-brainer.  The subjects of these tax
increases can afford to borrow money and/or dip into savings to keep-up
their pre-tax-increase level of consumption, while those at the other
end of the income spectrum spend (virtually) every last $ of income
-including if not entirely consisting of government transfer payments -
saving little, if anything.  No brainer!

Except, such "analysis" only makes sense in vacuo; When "the rich" become less-so, in a tax regime dependent upon them, it's not just the rich who suffer.

take-away is that States can't have their proverbial cake & eat it,
too.  In times of economic and financial distress, they can jack-up
taxes on "the rich," to their hearts' content, but they cannot do so
without consequence.  States prosper when the fortunes of "the rich"
increase and share in the pain when they decrease.

It seems States not only stick to Orszag & Stiglitz' suggestions,
but they seem intent on steadfastly embracing them to the very-end. 
Surely, when a State is already over-dependent upon tax receipts from
"the rich," the solution is to...increase such taxes even more, right? 
Where does it end, though? Round II?  Round III?  Never?

Eventually, "the rich" are going to wise-up and tell the states to
piss off, whether by severely decreasing their contributions to
Democrats, moving to a lower or no-income tax state, etc.  We're seeing
the beginning of this in New York, where many financial employees who
made substantial donations to the Democrats are having starting to have
second thoughts.  Caterpillar's CEO sent a note to Illinois' Governor last week about the possibility of moving the company to another lower-tax state.

How this will play-out is anybody's guess, but I think inevitably, at
least one state (perhaps Illinois or California) is going to be home to
an ugly income/tax inequality battle the likes of which haven't been
seen in the U.S. for decades if not centuries.

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Stuck on Zero's picture

When the U.S. was powerful and growing rapidly there were no income taxes.  All the government revenue was generated by import levies and tariffs.  This had the added benefit of keeping jobs at home.  Today we allow foreign companies to operate tax free while doubly taxing our own companies.  Makes a lot of sense, huh?

mdwagner's picture

Since the stock market doesn't do much to help anyone anymore other than the super-rich and CEO's, put capital gains taxes back to where they were.  Or even better, change to a transaction tax system so HFT have to pay the most taxes.

nah's picture
on Mon, 03/28/2011 - 08:01

and this just in

Syrian security forces open fire on hundreds of demonstrators in Deraa: witness


MakE TheM Pay MAkE TheM pay lol


git the rich or what rite... rebelion substitue is good for you... not that its all on topic but hey


revolutions tend to be epic and go on for more than say 10yrs... US, USSR, neapolean, christ... modern times baby dont seem so old

nah's picture

tell me you dont want somebody in charge


these fucking rich... who is their daddy and what does he do


comes down to government taking more or less of peoples individual 'power' for centralized political controll... imean watch the tv what do they say



baldski's picture

So, are Stone Street Advisors rich assholes? If they are, then they will be writing shit like this.

falak pema's picture

One sector that should be taxed minimally is the small business enterprise. But this taxation debate is shit sterile as long as there as tax havens world wide. All the multinationals NEVER pay taxes as they transfer price from tax havens. Shut down the tax havens INTERNATIONALLY and we can start playing hard ball with the Transnational corporations; those who wipe their asses on Main Street, those who pay the politicians, those who make the wars and poison the atmosphere...

Kim Jong-Il's picture

Typical Koch brothers propaganda.

Don't piss on my leg and tell me it's trickle down economics.

Buckaroo Banzai's picture

Ah, the Koch brothers. The new Bogeymen of the Left!


snowball777's picture

I hear they're looking for a fluffer. We'll send you an application.

Djirk's picture

Given the tax money via Fed monetization is being used to prop up the price of assets. It would be fair to have an asset tax, 1% of all assets. Like a property tax for securities.

eureka's picture

Taxation can not be understood in simplistic terms; 

Correlated Example:

1) Rates instituted are on thing, actual rates another, 

2) 15% of 20K (US med inc) leaves 17K to live on -

    35% of 10Mil (up 3% inc) leaves 6.5M to live on

    (if actually paid; not happening - offshored)

Consequently, since no income is earned without

communally created infrastructure -

relently executed, progressive income taxation is:

Rational, Fair And The Only Foundation of Community.

Bearster's picture

The incomes of the rich *are* predictable.  They will be cut back in response to adverse tax changes.  Ever wonder why a doctor has Thursday evening office hours?  He values the income more than time with his family  Raise his marginal tax rate (the tax rate on his Thu evening hours) to 80% and this will be proven upon your medically-needy hide!

Ever wonder why high net worth individuals take insane risks and invest in early stage startup businesses?  Raise the capital gains tax to 80% and then lament why there do not seem to be any innovative startups any more.

It is not a "theory" to deny this.  It is dishonesty and buffoonery.

snowball777's picture

How much can we make if we raise the tax rates on the unemployed?

Why should investment be incentivized more than working for a living?

If we make cap gains taxes 0%, will they invest all their income?


GoinFawr's picture

Well of course they will Snowball, jeez. Didn't you know that altruism is the only path to the top 1% of the ponzi?

Andy Lewis's picture

Wealth distribution is more lopsided to the high end than ever, yet real undisemployment is around 20%.  So this article ain't nuthin' but a crocka chickenshit bullshit. 

Buckaroo Banzai's picture

Holy shit. Where did all the socialists come from around here? Is DailyKos on fire or something?

GoinFawr's picture

narf narf.

Maybe you're just misnoming 'socialists' (like most americans have been heavily conditioned to do), and the comments are really just coming from 'mixed economy capitalists'. You know, those pesky realists who base their convictions on existing, functioning, successful economies instead of unwittingly promoting the neocon endgame via 'unicorn-based laissez faire' ideals.

GoinFawr's picture


Couldn't have said it better myself.

I got their 'trickle down' right here.

<rattles zipper>

PulauHantu29's picture

I heard a lecture at one of the MBA shcools and the panel said"the rich do not pay taxes."


Can that be true?

GoinFawr's picture

Anecdotal: I know a tax lawyer whose firm charges 600 fiat bux/hour to help those pulling in ten mil or more per annum minimize their share. And her business is booming, let me tell ya.

So, in my experience: yes, it is essentially true that the rich don't pay taxes. Certainly not anything like the percentage of their income that the 2nd and 3rd estates are coerced into paying. And the wealthy's percentage has been shrinking rapidly over the last decade too, IMHO.

ie The world is VERY "Free for those who can afford it, and very expensive for those who can't".

apberusdisvet's picture

With 5 years, Chicago will be a bigger Detroit; there will be no entrepreneurs left in California, and the good people in Taxachusetts will finally see the error of unbridled Keynesian entitlements and burn Barney in effigy.

jimijon's picture

Anecdote ... I live in Chicago, Illinois. Illinois is an official deadbeat state. It doesn't pay its bills. A worker over at UIC has money taken out for health insurance. I think the state pays for half. Well, said worker went to get medical care as was basically laughed out of the office as the medical establishment was not getting paid anymore. So, she would have to pay even more money to get the medical treatment she needed.

Again the state just takes the money and the benefits are nil.

snowball777's picture

Raise taxes on corporations, lower them on individuals.

For example, CA has a $1.2T SDP, yet collects < 8% of its tax base from corporations.

I'm betting you could make the corporate tax steeply regressive and leave small (for some rational definition of small) businesses unscathed and any corps which threaten capital flight would be in for a rather rude awakening when most of their talent turned out to be uninterested in moving to Wisconsin or Texas.

Buckaroo Banzai's picture

How about raising taxes on corporations, and ELIMINATING them on individuals.

Corporations are artificial persons, and creatures of the state. Being creatures of the state, they should pay their masters for the privilege of their creation.

Free human individuals, however, cannot be subject to an income tax in a free society. Income tax is a form of slavery, which-- if rule of law meant anything in this country-- was outlawed by the 13th amendment. When the state is given first claim to the fruits of your labor, you are-- by definition-- a slave to the state.

snowball777's picture

Those individuals don't use any of the resources from this country in your worldview? While I don't believe we should be subsidizing fictional persons who benefit greatly from same, I have no problem with paying a fair price for my ticket to the show.

You really want to contract to have your own sewers built and go to war with your neighbors when theirs overflow onto the property you will be personally defending from Chinese invasion? Idealism is great for books but sucks when boots hit ground.

The stereotypical libertarian victim mentality is tiresome at best; the state is neither all blessing or all curse.

Buckaroo Banzai's picture

Ah, the income-tax-lovers lament-- "but...but...but...who's going to pay for the ROADS??!?"

Did you ever wonder how this country managed to get by for almost 150 years without an income tax?

We used excise taxes. Which were fair taxes, and worked just fine.

Paladin en passant's picture

when most of their talent turned out to be uninterested in moving to Wisconsin or Texas.

Yep...that's why California's population is growing so much and the states around it are shrinking so terribly.

You seem to assume every corporation is as cool as Apple to work for. Most are quite mundane and the coolness factor of living in California is beginning to be outweighed by the stupidity of its governments, schools and universities.

snowball777's picture

CA 2000-2010 +9.1%

or +3M

or 1% of the entire US.

or 150% of the entire population of Nevada in 2000

or 150% of the population growth of NV and AZ combined since 2000.

And we still have 2.9M firms to Texas' 1.7M...hmmm...something's wrong with your theory, Hoss.

leathaface's picture

I love all this talk about tax rates, and who should be paying their fair share.  If they just simplified the fucking tax code (ie. flat tax or consumption tax), it would makes things a lot easier.  IMO, a consumption tax would be the best.  If you dont want to pay a lot in taxes, dont consume so much shit.  As an earlier poster said, the govt doesnt have a revenue problem, they have a fucking spending problem.  The rest is just noise.  Maybe our Govt should get out of the Welfare business, and just do the basics.  I am fairly young, and cant believe how reliant people are on the govt.  Think about how many different industries are subsidized.  Nevermind, the fact that we throw $ to the IMF for other countries BS.  Or, that we just like to go start ridiculous wars that we dont even factor into the budget.

Getting off topic, but this shit pisses me off!

snowball777's picture

Consumption taxes are attractive for the reasons you outlined, but the revenue from them can be rather elastic (and not in a good way) as has been evidenced by Texas' issues with a sales tax based regime of late.

Do property taxes ('consuming' land over time) fit your definition too?

You are young and probably don't even realize how reliant you are on the government, but you'll get your chance to find out soon.

leathaface's picture

If the states only spent money they were taking in, as opposed to going so far into debt they cant even see straight, then we probably would not be in this bad of shape financially. 

i think property taxes are ridiculous as well.  Notice how they are still going up as property values fall.  Just another confiscation of wealth.  You should pay a one time tax on your property (which could be part of the loan/mortgage).  For intstance, if you buy a place for $100k, and the tax rate is 9%, then you pay that $9k to the govt once and then you own your place.  No one truly owns their property when they have to pay property taxes for life to the govt. 

i think the govt is going to find out how reliant they are on the citizens, and that they cannot keep raping them at every turn.  People will just move more to a black market system (obviously not w/ property) if the govt keeps imposing taxes on everything. 

Shouldnt the govt treat their finances like the (responsible) people do?  Responsible citizens dont go this far into debt and think that spending more, or begging their employer for more money is going to make it better.  You have to first cut out erroneous spending.  But in the case of the govt, they dont beg the citizens, they hold a proverbial gun to their head w/ the threat of jail time for not paying taxes.

just my 2 cents

snowball777's picture

So you want to occupy land in perpetuity, only pay a 10% tax, but have access to services (like say...firefighters) as long as you live there? Nice theory. If you'll be contracting this out to a private company, do you really think you'll be paying less for the same service? Our operators are currently busy, please hold.

Black markets sound anyone who hasn't actually been burned and had zero recourse after the fact.

How much do you think you could really cut from this 'erroneous' spending and maintain our quality of life in the US? If the government were 'responsible' in this fashion, they'd start executing seniors, leave the economy with 60% unemployment, and you would be walking to work because there wouldn't be any oil to put in your gas tank.


jimijon's picture

Simple... no one lives forever. Eliminate trusts on property. Then every time the "owner" dies and an owner has to be a living person, then you tax the new transaction.

jimijon's picture

In fact, keep what I said above and add... all non-primary real estate is taxed yearly. That kind can be put into trusts and of course taxed.

Augustus's picture

A novel solution would be:

IF "we all" know that "we all" must have all of these programs and benefits, 

THEN "we all" are going to have to get with the program and help pay for it.

Drop the cell phone, cable subscription, fish tank, big screen home entertainment and potato chips.  Pay for the benefit programs.

Urban Redneck's picture

And if the economy magically turns around then the state government has windfall tax receipts due to the variability of the AGI of top earners, is the state to going to turn that extra money to only “the rich” from whom it came.  FUCK NO, they will spend it on some “investment”, the state is a kleptocrat employment bureau, and Stiglitz & Orszag are nothing more than thieving nerds drafting intellectual pseudo-economic cover for wealth redistribution.

ElTerco's picture

We need to cut, or at minimum freeze, spending as Congress and the state Assemblies have finally begun to realize.  They finally "get it", at least for the near term.

tgatliff's picture

I would be a nice solution if it had happened a decade earlier... However, the problem is too large now.. Only a massive reset at this point will solve the issue.   The key is how the largely insolvent financial institutions are handled.  They own over 55% of the US debt, and most of it is highly leveraged.   Deal with the mega financial groups and you will have effectively solved the debt problem..


ElTerco's picture

I'm all for lower taxes, but I'm all against BS.  The higest federal tax rate was north of 80% in 1950's for a *ten year stretch* and we had more general prosperity then than we have now.  I pay north of 10% of state taxes in CA, so I'm not happy about it.  On the other hand, the economy is in an emergency situation, and we need to fix it rather than run the country into the ground.  Finally, there is a difference between the tax rate and the effective tax rate.  The effective tax rate gets lower and lower as you become richer and richer.  Warren Buffet likes to point out that his effective tax rate is lower than his maid's.

docj's picture

The prosperity of the 50's had way more to do with being the only surviving industrial economy to come out of World War II than did anything involving taxes.  But hey, any time you want to bring back the level of "services" provided by fed/state gubermints in the 50's is A-OK with me.

BTW, the budget situation in Commiefornia has been an "emergency" for a decade, and wil be so for years to come.  At that point, it's not really an "emergency" anymore - it's the "new normal".

Buckaroo Banzai's picture

You are confusing correlation with causation-- rookie mistake.

Plus, the income tax code had more holes in it back then than a swiss cheese. Don't be fooled by nominal rates.

Eternal Student's picture

+1. The State Street Advisors article is just such complete BS it's disgusting. One has to ignore an awful lot of reality and actual successful examples to swallow this garbage.

Sorry, SSA. We need to make this a better society for the middle class. SSA is clearly geared towards the Wall Street Bankers and supporting them with this nonsense.

Buckaroo Banzai's picture

Um, ever think there might be a reason why you're an eternal student?

Broomer's picture

In the fifties the American oil production was still growing.

Same happens to Texan prosperity. Take out their oil, see what happens.

Augustus's picture

It is not particulary about oil in Texas,

It is about producing something of value at a profit.

falak pema's picture

First of all you need honest government...the rest follows...Pericles and the State...As for traders of WS they are at best people who load the carts in the fish market...not the lords of the world...Never. (I know never say never, but I still believe in the Rubicon : the line between Republic and Totalitarian state).

(BTW Merkel lost in Baden-Wurttemberg).

SqueekyFromm's picture

Well, IMHO, taxing the rich is better and more humane than guillotining them. Plus, all these really stupid people miss the positive impact that high tax rates have on employment. Put a 70% individual tax rate in, and people will start getting hired like crazy. Plus, there are other reasons to raise taxes. I did a Internet Article on "How Rich People are Like Mattresses" which explains how it keeps American capital to going to place like China.

Squeeky Fromm, Girl Reporter

Cpl Hicks's picture

Hey, need need to feel humble; you're a genius!

"Put a 70% individual tax rate in, and people will start getting hired like crazy."