It's Easier to Raise Taxes on the Rich, but More Effective on the Poor

It all started with Warren Buffett, who called upon the American government to raise taxes on the rich in order to share the burden of the financial crisis. Buffett’s appeal had the desired effect, and the proposal of raising taxes on the wealthy is no longer a taboo subject.

The process of raising taxes on the rich is already underway. Few remember what the British government did in 2010, when they raised the marginal tax rate to 50 percent on incomes above £150,000 a year. This affected nearly 300,000 British citizens.

France had also jumped the gun on Buffett’s appeal and proposed an additional 3 percent tax on individuals making more than €500,000 annually. This proposal has already been accepted by the legislature. Soon, rich Italians will have to pay a “solidarity” tax, which will affect all citizens making more than €300,000.

Buffett’s plea has been heard by Barack Obama. On Sept. 19, Obama announced his new jobs act. He also highlighted the inadequacy of merely cutting government spending and proposed revisiting the issue of raising taxes on millionaires. The president repeated the mantra that Buffett pays a lower rate than his secretary as proof of the righteousness of these tax hikes.

The cure for this injustice is the so-called Buffett Rule. The rich will not be able to pay a rate any lower than the national average. The American average is now 23.5 percent, while the rich sometimes pay as low as 15 percent. The rule would apply to all people who earn $1 million or more. The American president asserted that his new proposals did not punish success, but were rather an attempt at fairness.

Low Taxes Are a Thing of the Past

The above initiatives are just a harbinger of what awaits us in our tax reforms for years to come. The era of low taxes is over, regardless of what incomes are. The possibility of tax hikes across the board is very real and actually a matter of “when” rather than “if.” The belief that only the rich will shoulder the burden of recovery is unrealistic.

Poland had also flirted with a special tax bracket for the rich. The left-leaning Social Democrats attempted to levy a 50 percent tax on all Poles who earned more than 600,000 PLN per annum, but the measure was blocked by the Constitutional Tribunal. The Tribunal, however, did not question the justice of a 50 percent tax, but rather opposed the method of its enactment. Polish politicians can theoretically come back to this project one day.

Who Really Contributes to the Budget

Does raising taxes accomplish anything other than making for good propaganda? The problem with these taxes is the low number of people who actually qualify. The returns on these taxes will not be enough, unless the millionaire taxes are precursors for all-encompassing tax hikes. This is very possible.

Let’s imagine a city where 100,000 residents make $24,000 a year and 10 make $1 million. Everyone pays a flat rate of 15 percent. This means that 100,000 residents would pay $3,600 in taxes a year. The millionaires would pay $150,000. The ordinary citizens contribute $360 million to the budget, but the millionaire taxes would only add $1.5 million. The majority of the budget is comprised of the taxes of ordinary citizens, simply because they are the overwhelming majority.

Now let’s suppose that the city, hit hard by the financial crisis, is looking for new revenue. They decide to raise the millionaire tax rate to 90 percent. How much do they gain? Very little. Each of the millionaires, provided that they don’t run away to another city, would have to pay $900,000 in taxes, but the budget would increase to $9 million, a $7.5 million increase, which translates to a mere 2 percent increase in the budget.

What can the city government do to get more revenue? They could raise taxes on the rest of the citizens by 1 percent. Compared to the 90 percent increase for revenue, the 1 percent is nothing. Each citizen will pay $3,840 in taxes. Together, they will pay $384 million into the budget, exactly $24 million more than the year before. Every percentage point is worth $24 million. Which tax increase is more effective? Which group is worth more?

The answer is clear. In practice, raising taxes on the few is ineffective. It is not the individual contribution that counts, but the scale. Even a small tax increase on everyone generates larger tax revenues than exorbitant taxes on the rich. Taxes on the rich do not solve budget problems. They do, however, open the door for tax hikes for everyone. Raising taxes for one group precipitates a raise for everyone.

First Come the Rich, Then Come the Poor

The deeper a government can reach into the pockets of rich citizens, the more likely it is to raise taxes on the middle and lower classes. They can always argue that, compared to the sharp tax hikes on the rich, the hikes on the non-rich are minuscule. This, of course, is a lie. Any attempts to raise taxes on the rich cause a mass exodus to countries with lower rates of taxation.

In our example, it is within the realm of possibility that the tax hikes on the rich would result in a loss of $1.5 million rather than a gain of $7.5 million, due to all the millionaires leaving the city for somewhere where taxes are the same or lower. This is a process that can be observed in Poland today.

Zbigniew Jakubas, an investor worth over $260 million according to Forbes magazine, said in a recent interview that, “Raising taxes might lead to a situation where people won’t pay them at all and will start looking for alternatives.”

What can governments do to raise revenue? Paradoxically, they can lower taxes for the financial elite as low as possible, to make the country more attractive than any other country. A government that lowers taxes might witness an influx of rich immigrants from other countries.

Going back to the city example, if the government decided to not raise taxes, they could possibly gain $1.5 million for every 10 millionaires that come from somewhere else. If the number of millionaires rose to 100, the extra revenue would amount to $13.5 million. Lowering taxes could potentially result in more revenue than a tax rate of 90 percent. The problem with this method is the political risk involved.

We have entered the age of higher taxation, and the trend of higher taxes will be replicated all over the world. The cost of upkeep of the bloated governments has increased, and taxes will follow suit.

The question remains: How high will taxes go? By testing new tax rates on a small segment of the population, the process has already begun.