Why "Tax the Rich" Won't Work!

by Charles Hugh Smith at the Of Two Minds blog:


Will "Tax the Rich" Solve Our Deficit/Spending Crisis?   (December 28, 2011)
If we look at tax revenues and income in a practical way, we find "tax the rich" will not close the widening $1.5 trillion gap between Federal revenues and spending.
Clearly, $1.5 trillion annual Federal deficits to fund the Status Quo--fully 10% of the nation's GDP--is unsustainable. Eventually, the ad hoc "solutions" currently being pushed by the Federal Reserve--zero interest rates to keep borrowing costs artificially low and money-printing operations that buy Treasury debt--will encounter political and/or market pressures which will limit the marginal effectiveness of these interventions, and the real cost of these historically unprecedented deficits will trigger a host of unintended consequences--all negative.
Everyone knows there are only two ways to bring deficits back to sustainable levels: skim more tax revenues from the national income or cut spending on the massive Status Quo programs of Defense/National Security, Medicare/Medicaid and Social Security. The rest of the Federal programs so reviled by various constituencies are a relative drop in the bucket.
Everyone with a stake in the Status Quo Federal spending--and that is certainly in excess of 100 million residents of the U.S.--is vocally in favor of "taxing the rich" as the "obvious and just solution" to the widening gap between revenues and spending.
If there is one stance that can gather non-partisan support, it's "tax the rich." More knowledgeable observers refine this to "tax the super-rich," as the majority of the wealth and income of the top 1% is actually held by the top 1/10th of 1%.
We can break this idea down into two basic parts: the ethical case and the revenue case. Ethically, at least in a democracy, the idea that everyone with substantial wealth and income should pay at least as much (as a percentage of income) as wage-earning citizens is compelling.
Various studies have found that the extremely wealthy pay about 17% of their income in Federal taxes, which is less than half of what we self-employed people pay (15.6% self-employment + 25% Federal tax on all income above about $34,000 = 40.6%).
The merely well-off--typically professionals, managers and small business owners--pay the majority of Federal taxes, with the very wealthy paying a substantial share as well. Roughly half of all those filing tax returns pay no Federal tax other than the employees' 7.65% FICA (Social Security) tax.
In the larger scheme of things, the bottom 60% of the workforce pays relatively little of the total Federal tax revenues. (Check U.S. Census records or search my site for sources that break down the sources of Federal tax revenues.)
In other words, the "rich"--or those who the average person considers "rich"--already pay most of the Federal taxes.
How much additional tax could be raised were the super-wealthy to pay the same 40% rate that we self-employed people pay? It is tempting to estimate that another $1 trillion or so could be raised from the super-wealthy, largely from non-wage (unearned) income.
I have addressed this yawning gap between spending and revenues in the past, for example:
The Promises That Cannot Be Kept (July 6, 2011)
As noted in the above entry (the TrimTabs chart), Americans' after-tax income is around $5.3 trillion and $900 billion in income from "other sources." Additional taxes would of course come from current after tax-income. It's difficult to sort out all the various measures of income; the BEA, for example, includes "government transfers" as personal income--though those transfers come from tax revenues.
Including government transfers and arcane categories such as "inventory valuation adjustment (IVA) and capital consumption adjustment (CCAdj)", the BEA counts $12 trillion in earned income. But if strip out transfers and inventory adjustments etc., that number drops to around $8.4 trillion. (Two Americas: The Gap Between the Top 5% and the Bottom 95% Widens August 18, 2010)
Total Federal tax revenues are about $630 billion from Social Security taxes and $1.5 trillion from Federal income taxes, or a total of $2.1 trillion. To Fix Social Security, First Ask Why It Is Deep in the Red (January 18, 2011).
There are local and state taxes, too, of course, which leaves the $6.2 trillion in after-tax income noted earlier. Since the top 10% collect roughly half the income, we can guesstimate that the top 10% receives about $3 trillion. To balance the current budget, they would need to pay 50% of their after-tax income ($1.5 trillion)--on top of the substantial taxes they already pay. (maybe the top 1/10th of 1% pay 17%, but the merely wealthy pay much higher rates on earned income.)
Add this up and you get tax rates of around 65% on the top 10% (25% total income rate plus 50% of the remaining income).
We then have to ask whether these rates would ever be collected.
There are a number of factors that affect actual tax collections from theoretical calculations. One is that Congress is a collection of wealthy people who are seeking to increase their power while minimizing their taxes and those paid by their cronies and contributors. As long as this is the case, then the tax code will continue to be thousands of pages long with exclusions, taxbreaks and exemptions for the politically connected wealthy.
Another is that studies have found Federal tax collections have historically topped out around 21% of total income. Above that level, people make choices that reduce their tax burdens.
Just as a thought experiment, put yourself in the shoes of someone with $20 million in assets and an income of $1 million. First off, you have a tax attorney who works the complex tax code to put as much of your income as possible in lower-rate income--for example, long-term capital gains.
Wealthy individuals shelter their income and assets with corporations, which have many more options in terms of shifting income.
Secondly, you have overseas accounts, assets and options. Let's say you are ethical, and pay your legal taxes without resorting to questionable tax havens. Let's stipulate that you are just like any other taxpayer--you feel no obligation to pay more than your legal share.
International agreements mean that income need only be declared and taxes paid on it in one jurisdiction. So income declared in Switzerland is exempt from taxes in the U.S., as taxes have already been paid in Switzerland.
Though I am not that knowledgeable about tax law, anecdotally it seems total tax rates in Switzerland are around 25%. If rates in the U.S. were jacked to 50% or higher, then very wealthy individuals will shift income to places like Switzerland and pay the lower tax rates there--perfectly legally. They would also liquidate assets in states which attempted to raise taxes on real property or enterprises, and shift those assets to lower-tax states or nations.
This would not be perceived as "tax avoidance," but as rational money management. In this sense, the super-wealthy are simply doing what every household does--attempt to lower taxes by whatever legal means are available. The means available to those with income and assets that can be shifted around are simply more capacious.
In practical terms, collecting another $1.5 trillion annually is problematic on multiple levels. Practically speaking, it might be wise to align total U.S. tax burdens with those of Switzerland and similar developed-world tax havens, for those essentially set the top rate that very wealthy individuals will pay.
Such a system would flatten taxation rates and very likely increase total tax collections. But it is simply not practical to think that the Federal government can skim 45% of the nation's $8.4 trillion in income to fund the bloated, corrupt and inefficient $3.7 trillion Federal budget.
How about those soaring corporate profits? If we taxed 100% of the $1.5 trillion corporate profits, then we could close the $1.5 trillion budget deficit. But then Wall Street would have nothing to support those sky-high stock valuations.

"...there are only two kinds of paper money - those which are already worthless and those which are going to be worthless"

"Before it can be exchanged, wealth must be created. Wealth cannot be created out of thin air. By definition, an economic good is “scarce”. If it were not, there would be no such thing as economics or exchange. Neither would be necessary because no effort or choice in the face of alternatives would be required in order to provide the GOODS which further our lives. Before we can talk about money and the VITAL role it performs, we must stress this point. Money is NOT wealth, it is the means by which wealth is exchanged amongst those who produce it. Paper money is not suited to this function...

The paper money “price” of Gold will last as long as the attempt to make paper money “work” lasts. In the end, Gold will no longer have a “price” because it has reverted to its role as MONEY. Whenever and wherever that happens, that nation can return to the production of wealth - rather than “money”.

 -- Bill Buckler

Household Net Worth Plunges Even While Government Debt Soars

This metric is going in precisely the wrong direction!

from Zero Hedge:

Arguably the most useful report to come out each quarter out of the Federal Reserve is the Z.1, or the Flow of Funds report, which was released minutes ago. And it's a doozy: household net worth (assets less liabilities) in Q2 2010 plunged by $1.5 trillion, almost exclusively due to a plunge in Corporate Equities ($0.9 trillion) and Pension Fund holdings ($0.7 trillion). In other words, the net wealth of the US household continues to track the performance of the stock market tick for tick. And one wonders why the Fed, per Alan Greenspan's admission, is only focused on ramping stocks up to all time highs. Total household financial assets declined by $1.7 trillion to $43.7 trillion, which was the biggest swing factor, as the tangible assets, or housing, was kept flat at $23.7 trillion. Incidentally, to assume that Real Estate value increased in Q2 from $18.7 trillion to $18.8 trillion in Q2, is one of the dumbest things to ever come out of the Fed: we expect that this number will plunge soon after it is realized that the double dip in housing is here, forcing another major contraction in household net worth. On the other side of the balance sheet, liabilities were also flat at $13.9 trillion sequentially. And possibly the most important data point: the change in borrowings, confirmed that everyone is deleveraging except for the government... whose borrowing surged at a 24.4% SAAR, the second highest ever, after the 28.9% surge in Q2 2009. In other words, Keynesianism is alive an well in the US, and any talk of austerity in the US is nothing less than not that funny stand up comedy.
Chart showing total financial asset breakdown: at $43.7 trillion, US consumers are now back to the same net worth levels they had in Q3 of 2009.

Super-Rich Not Buying the Bull!

from CNBC:
They say the rich aren’t like you and me. Well guess what? They’re not investing like we are, either.

As you might remember from Monday’s Fast Money, the traders talked about how sentiment in the market has turned from broadly bearish to broadly bullish. Karen Finerman said she was afraid to be short. “As a hedge fund manager I can’t risk being under-invested and missing the moves,” she explained.

Steve Grasso, managing director of institutional trading at Stuart Frankel told the panel his money manager clients feel the same way.

Perhaps this quote from Angel Mata of Stifel Nicolaus sums it up best. “The one thing that's driving this market more than anything is the fear that as an investor, you're missing out on something big."

Well guess what? The rich don’t exactly feel that way.

In fact, you might say they don’t feel that way at all. And from how they’re investing, they’re not nearly as bullish as the rest of us.

Mark Axelowitz, director of wealth management at Morgan Stanley Smith Barney advises some of the richest people in the world. And he’s spotted three trends among the ultra high net worth crowd.

The high net worth are:

1. Cautious and not chasing the rally

2. Heavy into fixed income, only moving some into equities

3. Not ready to trust the system enough to dive in with both feet.

It’s ironic. The wealthy could probably afford to be a little more aggressive in this market. We mean, losing a million or two on a wrong-way bet wouldn’t seem like a big deal to these folks.

Yet from what Axelowtiz tells us, it’s just the opposite. The super-rich appear to be super-conservative and more important, unwilling to bet on this bull. Perhaps that’s why they’re so rich.

"When you’re a high net worth investor, you win by not losing,” says Axelowitz. Are they onto something. What do you think? We want to know!