“Tax the rich” has become a clarion call of governments across the developed world.
This week, the European Union announced a pledge by Austria and Luxemburg to put an end to tax havens for the rich by sharing once-secret banking, trust and foundation data with other member states. Barack Obama’s latest budget focused on raising revenue by ending tax breaks and loopholes “for millionaires and billionaires.” And in Canada, provinces have made taxes on the well-off a priority: Nova Scotia and Quebec have both raised top tax rates, Ontario has established a whole new tax bracket for those who earn more than $500,000 a year and the premier’s race in British Columbia earlier this month included bids from both leading parties to hike tax rates for the wealthy.
The combined one-two punch of the financial crisis – slow to no economic growth matched by rising public debts and persistent deficits – has thrown into question the sustainability of many entitlement programs we take for granted. Layer over these anxieties the perception that poor and middle-class incomes are stagnating while the wealthiest in society enjoy spectacular income gains, and a healthy dose of wealth redistribution seems not only prudent public policy but a basic issue of fairness.
But does taxing the rich really pay off? Can it bail out debt-laden economies or curb a rising tide of inequality? Is there, in fact, a value to tax cuts, not only for high earners but our slow-growing economies?
Icons of both the left (Paul Krugman) and the right (Newt Gingrich) will attempt to answer this question at next week’s Munk Debates in Toronto. Until then, however, here are three reasons why the case for taxing the rich may not be a clear-cut as we have come to think.
1. Tax cuts can make more money for government coffers
Exhibit A against taxing the rich is what’s called the “Laffer Curve,” after American economist Arthur Laffer.
At one end of his curve is a tax rate of zero. At the other end, a tax rate of 100 per cent. Neither, notes Mr. Laffer, produce tax revenue – in one case because there is no tax, in another because the economy is assumed to grind to a halt when all wealth creation is expropriated by the government. The goal, of course, is to reach the peak of the curve, the point of greatest possible tax revenue.
The trick is this: Tax cuts affect tax revenue less than simple arithmetic can explain. A 50-per-cent reduction in the tax rate does not necessarily halve revenues. Why? Because tax cuts can actually encourage people to increase their economic output, thereby producing more taxable activity.
The most-cited example of the Laffer Curve at work comes from the 1980s, when Mr. Laffer was a key economic adviser to U.S. president Ronald Reagan. The top marginal tax rate was slashed to 30 from 70 per cent – and instead of draining government revenues, they doubled them over the decade that followed.
How that money is spent is another question (as many critics of Reaganomics would contend). But the bottom line is clear: Tax cuts don’t always have the intended effect. Nor do tax hikes. Particularly when it comes to the ultrawealthy. The superrich are also supersensitive to tax raises, especially when they come on top of high base rates (in Canada, the top 1 per cent of tax filers pay one-fifth of all income taxes).
Ask the French, who are now facing their third recession in five years. President François Hollande’s promised 75-per-cent tax on earners who make more than a million euros a year helped trigger an exodus of wealth from the country, including the infamous defection of Gérard Depardieu.
2. Taxing the rich is not an efficient solution to inequality
From the mid-1970s onward, middle-income Canadians saw their take-home pay increase by a modest 14 per cent while incomes for the top fifth of Canadian families surged by 43 per cent. The U.S. situation is even starker: Two decades of middle-class stagnation combined with the housing collapse and persistent unemployment has led to a gap in which the richest 400 Americans now possess more wealth than the bottom 150 million of their fellow citizens. All of which naturally raises concern about the concentration of wealth – as well as power.
But what if the aggregation of wealth correlates to specific geographic locations and industries as opposed to society at large? Is taxing income the best way to even the playing field?
Here, the work of economist James K. Galbraith is illuminating. His research, which covered the early 1990s to the millennium, showed that if you separate out the wealthiest 15 U.S. counties, you see no change in income inequality among the 3,143 counties that remain. What this suggests is that the income gap in the 1990s was driven by the rise of a few key sectors, such as finance and the high-tech booms in California and elsewhere.
In Canada, while there is no comparable study, census data suggest a similar pattern: Rapid income growth is focused in a handful of ridings – in Toronto, Calgary and Vancouver – tied to sectors such as finance and resource extraction.
If all this is true, then raising taxes on the wealthiest Canadians to combat rising economic inequality is the policy equivalent of performing heart surgery with a meat cleaver. A more targeted way to redistribute wealth from high-performing to struggling sectors of the economy might be a European-style tax on financial transactions, or a carbon tax aimed not at consumers but at large energy producers and natural-resource companies.
As for power, unlike in the United States, the influence of the rich in Canada is limited by strict political donation and campaign-finance laws. Unlike America’s superPACs, unlimited corporate donations and billionaire political dabblers, our national politics is blissfully insulated from great wealth and its power to undermine public purpose for private interests and profit.
3. We are richer than we think
Discussions about taxing the rich naturally focus on disparities. Among the complaints are the details: $1,000,000 cottages, $100,000 cars, $1,000 handbags. In other words: Look at all their stuff! But if the rich have more (and more expensive) stuff, does that mean the rest of us have less? It turns out that the “consumption gap” between different income groups is far more constant than we might expect.Take the United States, the poster child for economic inequality and the acquisition of stuff in the developed world. In the early 2000s, the top 20 per cent of Americans accounted for almost 40 per cent of all consumption, the middle fifth 17 per cent and the bottom fifth 9 per cent. Cue the dot-com bust, the financial crisis, the housing collapse and global outsourcing. Yet by 2010, the same three groups claim almost exactly the same shares of consumption.
Consumption is not the only measure of well-being – and is sometimes seen as symptom of a larger social malaise. Some of the buying in the U.S. was fuelled by credit binges (which in turn played a not unimportant role in the severity of the housing market collapse). And, any way you slice it, everything from educational levels to longevity have more than a casual correlation to personal or family income levels.
But even on those measures, would any of us say we’re worse off than the generation or two that came before us? In addition to what we buy, we have, arguably, an economy that sustains a better quality of public health care, accessible mass technology in the form of cellphones and computers, and benefits such as cleaner air and lower crime rates.
To paraphrase a certain bank’s slogan, maybe we are, in fact, “richer than we think.” Despite the worst financial crisis since the Depression, despite the disruptive effects of globalization and the rise of income inequality, the West continues to create comparatively high living standards for rich, middle and low income earners alike.
Rudyard Griffiths is the director and moderator of Toronto’s Munk Debates, taking place Thursday.