Tax the Top, Hit the Middle
By Daniel Cross
“Tax the rich” has been the inveterate battle cry of liberals from the beginning. The left believes in creating massive entitlement and welfare programs all in the name of fairness. Equal rights, it seems, don’t apply to the wealthy. Ironically, the idea only ends up hurting the very people it’s supposed to help.
Early in 2009, Maryland raised its tax rate to 6.25% for income earners of $1 million or more and saw a decline in tax revenue as high-income taxpayers emigrated to tax-friendlier states. While it may seem that few families make an income of a million dollars, sole proprietorships, partnerships, and many “S” corporations pass their earnings directly through to the individual, and that means that small businesses are the ones that get hurt the most.
Tax increases of this kind have far-reaching consequences. Small businesses that move don’t often take employees with them, and those that stay may be forced to cut back, resulting in higher unemployment numbers. In Maryland’s case, the drop in tax revenue also means that the burden is placed squarely on the shoulders of the middle class, the ones who can least afford it. (Usually Democrats deal with this problem by creating subsidy programs that only widen the gap in wealth disparity with more taxes. It’s this type of circular logic that keeps class warfare alive.)
While leaving one state for another due to taxes may be an option, what happens when the federal tax rate increases? Few are willing to go so far as to leave the country to escape taxation, yet the same decease in tax revenue can be found on a national scale. The reverse of this effect can be seen by looking back at the tax policies implemented by Andrew Mellon, the Secretary of the Treasury under Calvin Coolidge, in the 1920s. By lowering taxes across the board, the United States actually saw a surplus and used the money to help retire some of the national debt.
A true return on an investment can be calculated only after applying the corresponding tax rate. The higher the rate, the less return is realized. For the wealthy, reducing the amount of money subject to taxation becomes a necessary strategy to justify the level of risk taken in any given investment. As the tax rate goes up, the amount of risk that needs to be taken in order to make the same return also increases.
Municipal bonds are a unique type of investment products that provide tax-free income at the federal and potentially even state and local level. This makes them more attractive than the oft-lower-yielding Treasury securities, which are tax-free only at the federal level. Obviously, more money in these products will result in fewer income taxes collected.
Let’s take a look at an example to help illustrate how this works. The equation used to determine a comparable taxed investment versus a tax-free one is Taxed Comparable = Tax Free Comparable / (1-Tax Rate). If an investor’s tax bracket is 35%, and he can invest his money tax-free at 6%, then the amount he needs to make from a taxable investment is 9.2% [9.2% = 6% / (1-35%)]. Now, what happens if taxes are raised to 45% instead of 35%? In this case, the investor would need to make 10.9% in order to make the same amount of money as the tax-free one at 6%.
The real problem occurs when taxes are raised during a recession, as Herbert Hoover found out the hard way. Many times, there are no comparable taxable investments, so investment funds flow into municipals and treasury bills en masse. With no incentive to invest and pay taxes, investors opt for a better strategy, thereby reducing the amount of money the federal government collects.
In recent years, the proliferation of brokerage firms and computer-based transactions has made transferring assets even easier. Thanks to technology, the act of investing offshore to lessen or even avoid taxation, once limited only to the ultra-rich, has become more commonplace. On January 1st, 1980, 401Ks were created, allowing even more people to shelter their income by deferring taxation until retirement.
As the political landscape changes, taxes are just one more tool Democrats use as a way of “balancing” what they see as an unfair system. To those who don’t know any better, the idea of taxing the top income earners in America can sound very appealing, especially when you’re living paycheck to paycheck. The economic truth is kept hidden away, and ignorant votes create more problems for the disappearing middle class. The rise of the salient “Tea Parties” may finally shine a light on how the American tax system is designed and educate voters in a way that allows them to see through incorrect leftist philosophies. It’s a progressive mindset that actually works.