Tax the Rich Policy: A Critical Analysis

There are few issues which strike through the heart of communists in China and capitalists in America similarly. One such issue is the issue of taxes, particularly the taxes that are levied on people of the extremely high income category.

The popular opinion is that the rich somehow collude with the politicians to create a convoluted plan wherein politicians generate tax revenue from the poor employees whereas the millionaires are given a free pass! The method used is a complicated system of multiple taxes which has loopholes built in deliberately to allow the rich to take advantage.

This sentiment was seen on popular display during the Occupy movement that started in the United States in 2012. During the movement, protestors claimed that 1% of economically powerful individuals were marginalizing the interests of 99% of the hardworking population.

Comments by billionaire investor Warren Buffet further added fuel to the fire as he proclaimed that he was taxed at a lower rate i.e. a lower proportion of his income than his household help was!

The resultant debate has created squalor which can be heard across the entire nation. From presidential corridors to news debates, the issue of taxing the rich gets immediate and complete attention of the masses.

In this article, we will critically analyze the popular opinion. Maybe the entire issue of “taxing the rich” is the result of collective envy of the masses towards some successful individuals.

Justifying collective envy to create tax laws would make the United States a “mobocracy” rather than a democracy. Let’s therefore understand, why taxing the rich may not be a very sensible option:

Fairness

The underlying belief is that every tax system in America and across the world needs to be progressive. This means that as your income increases, you need a smaller portion of your income for food, clothing and shelter. Therefore, you are in a position to contribute a larger sum to the collective pool of money. Hence, the tax collection from the wealthy should ideally form the basis of a tax system.

This is exactly the case in the United States of America. Popular opinion may be biased but statistics are not. Statistics show that the richest 1% contributes more that 40% of the total taxes that are collected by the exchequer. Also, when the richest 5% are included, the taxes collected amount to over 65% of the taxes collected.

Hence, while there may be some truth to Warren Buffet’s statement, it is only because capital gains are taxed at a lower rate as compared to salary income. But stating only that fact in isolation would amount to a travesty! One needs to understand that at the lower tax rate for capital gains, the government is still collecting the fair share of taxes from the rich.

In fact, a large portion of the economically weaker section do not pay taxes and are instead dependent on the welfare payments to be received from the government.

Sufficiency

The next parameter that needs to be looked at is whether the taxes being raised are sufficient. Alternatively, the government could be going into debt because it is conferring favors on the rich while falsely trying to make good on promises made to the poor.

This question can simply be answered by looking at the percentage of the Gross National Product the government earns as its own revenue. In the United States, the government collects 19% of the GNP as taxes! That’s a humungous sum of money by any estimate. So, the collection of taxes does not seem to be the problem. The United States government collects enough and even more and a majority of it is collected from the rich!

But, when we look at the expenditure of the United States government, things start to make more sense. This is because the United States government spends more than 24% of its GNP. That is 5 percentage points higher than what it earns via taxes. A majority of this expenditure is in the form of unproductive expenses like interest and entitlement payments.

Therefore, from a sufficiency point of view, the tax the rich argument does not hold much water. The cut down on excessive spending argument is the one that should be in the limelight.

Efficiency

Lastly, the question of efficiency in the economy arises. The rich capitalists are the ones that open more factories, more companies, create new products and therefore create more employment. If we tax the money out of the hands of these entrepreneurs, we would first be taking the money from them and then later incurring transaction costs to get the same money back into their hands via venture capital funds.

It may hurt a few sentiments however money in the hands of the wealthy is more productive as they use it for industrious purposes making the economy grow. On the other hand, poor use the money for consumption purposes. This creates demand in the short run but hampers the long term growth of the economy. It therefore makes more sense to tax productive endeavors at a lesser rate and hence the lower tax rate on capital gains is justified. This is not a loophole. Instead, it is a policy based on the backing of strong rational economic chain of thought.