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Will the Rich Stick Around to Be Soaked?

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On December 8, the website Breitbart heralded, “Despite Tax Increase, California State Revenues in Freefall.” In the November state elections, a successful Proposition 30 imposed a 13.3 percent tax rate on income over $1,000,000 — an increase of 29.13 percent and the highest state tax rate in the nation. The predicted tax revenue was hailed as a way to dig California out of its budget crisis. It was ‘“needed” especially to fund public-sector pensions with their plush benefits. Instead, state revenue for November 2012 fell by 10.8 percent, or $806.8 million. Wealthy businesses and individuals were leaving; many had left already.

Politicians seem genuinely surprised by the migration. After all, an academic study from the Stanford Center on Poverty and Inequality had assured them that the superrich were not a flight risk because other factors, such as personal connections, would make them stay.

Rather than commission studies, California should have made cautionary note of Europe where high tax rates are resulting in lowered tax revenue owing to “missing” millionaires. Some of them are missing in the literal sense of having moved elsewhere. Others are pursuing strategies to avoid the same “soak the rich” attitude now pervading America. Britain’s tale is one of the most instructive.

Where are the superrich Brits?

A November 27 headline in the British Telegraph read, “Two-thirds of millionaires left Britain to avoid 50p tax rate.” The article explained that “in the 2009-10 tax year, more than 16,000 people declared an annual income of more than £1 million” (approx. $1.6M) for tax purposes. In fiscal year 2010-11, only 6,000 millionaires filed and tax revenues sank by 60 percent, or from £13.4 billion to £6.5 billion. That was the year in which the tax rate on millionaires rose to 50 percent from 40 percent; the increase was expected to raise about £2.5 billion in extra taxes. In response to the decrease, the 2012 budget reduced the tax rate to 45 percent beginning April 2013, and 10,000 millionaires filed this year. That is still 6,000 off from the total in 2009-2010 during the height of the recession.

Other sources in Britain dispute the claim that millionaires have fled en masse and, given the EU’s open borders, the numbers are difficult to determine. But the financial data are uncontested. Some commentators explain a large part of the plunge by pointing to the wealth-preserving strategies being used by the superrich. One strategy is to reduce income and so become eligible for the much lower basic tax rate. Another is to retire early. Some choose “forestalling” — that is, to delay the payout of dividends until the 45 percent rate is in effect. Whatever approach is used by the superrich, tax revenues declined as rates ascended.

On November 28, Washington-based foreign-affairs analyst Nile Gardiner observed in the Telegraph, “There are important lessons here for the White House, and … for President Obama, who has pledged to force ‘the wealthiest Americans to pay a little more in taxes.’” Obama was determined to raise the top income tax rate for families earning $250,000 a year or more by nearly 5 percentage points, from 35 percent to 39.6 percent. By comparison, the top marginal individual income-tax rates in Singapore and Hong Kong are 20 and 15 percent respectively. (Obama later settled for a higher threshold, $400,000 for individuals and $450,000 for joint filers.)

Obama should also have looked to France, where the exodus of millionaires is not contested but highly decried. In September, socialist President François Hollande included a controversial tax hike in his first budget; the tax rate increased to 75 percent for incomes over €1 million (about $1.27 million). “Les riches” took flight. One of them was French superstar Gérard Depardieu, who has relocated to the neighboring French region of Belgium; 27 percent of the population of his new hometown of Nechin are reported to be French expatriates. Depardieu followed in the footsteps of France’s richest man, billionaire businessman Bernard Arnault. He has applied for Belgian citizenship. Although he claims to remain a “tax resident” of France, skeptics note that it is legally prudent for Arnault to deny tax evasion as a motive for the move. The response of the French public typifies the lack of sympathy shown to the rich by average people. The newspaper Libération ran a headline that translated to “Get lost, you rich bastard.”

Sanity prevailed, however, and the French Constitutional Council quickly struck down the tax as unconstitutional, but Depardieu said he would remain in Belgium.

Meanwhile, the world views the fleeing French as an opportunity. A headline in the Wall Street Journal declared, “Moving Sale: A Château on the Cheap?” The article explained, “The French are fleeing. A spate of proposed tax hikes is leading hundreds of wealthy French to consider leaving the country and putting their homes on the market, real-estate agents say. The result: the best opportunity in years for foreigners to buy a Parisian pied-à-terre or country château.” The influx of foreign buyers is a reminder of how fluid world populations have become, and how responsive they are to economic changes, including taxation.

Feed or starve the beast?

Libertarians want to starve the state because they view taxation as outright theft, and no one should be allowed to steal.

There are other, more mainstream reasons to oppose hiking taxes on the rich, however.

The rich have the resources and financial savvy to protect themselves by leaving the jurisdiction or by sculpting innovative tax avoidance. In a Forbes article (December 4) titled “Brits, Yanks and French Show Fleeing High Taxes Is Universal,” Robert W. Wood commented, “As a result, they [the rich] are precisely the ones you can’t push too far without an effect. They may not push back and may not tell you they are upset.” They may simply and silently leave.

“Tax the rich” creates a distorted and false atmosphere of class warfare. One category of society is pitted against another by enforcing the principle “from each according to his ability, to each according to his needs.” The rich and productive are burdened with supporting the poor and those on entitlements. Much tax revenue never comes close to reaching the poor. It goes toward corporate welfare in the form of subsidies and contracts, and it finances the lucrative intellectual-property regime. Thus the true impact of hiking taxes on the productive sector is the opposite of what is presented; it reduces the general standard of living by reducing the number of jobs and increasing the price of consumer goods. A more accurate statement of the class war being waged is government versus the private sector, crony capitalism versus the free market.

Income taxes punish hard work and create disincentives to invest. That is true of all taxes; every tax discourages production to some degree and so the ideal tax rate for economic health is zero. But it is especially on the margin that discouragement occurs because earning an extra $100 can then push a worker’s income into a higher tax bracket. Income taxes place many in the private sector on just such a margin. If zero taxation encourages a maximum of production, then a confiscatory tax rate encourages people to walk away from work.

An income tax hurts small businesses, which have been a traditional route out of poverty. Small businesses also constitute major competition for big crony businesses that receive corporate welfare. By applying a tax that disproportionately hits mom-and-pop businesses, this competition would be reduced in at least three ways. First, small business owners usually put business income on their personal tax returns, and if that income exceeds $250,000, they enter the higher tax bracket; downsizing the business becomes attractive. Second, people have less discretionary income to spend. Third, as noted earlier, there is less capital in society for the investments that enable business creation and expansion.

Many of the people being taxed are not what we traditionally think of as rich. For example, farmers facing an estate tax or real-estate tax may be treated like millionaires owing to the value of their acreage. The only way for them to pay the taxes may be to sell their farms.

One of the most compelling main-stream counterarguments, however, is that soak-the-rich taxes will not work; that is, they will not accomplish even the grievous goal of increasing tax revenues for entitlements and corporate welfare. But they will harm the economy by throwing up another disincentive to create jobs and to produce. That will harm the working class and the poor.

The Laffer curve

Why does a higher tax rate so often result in less tax revenue? The Laffer curve (illustrating a point made by 19th-century continental classical economists) offers a fascinating explanation. The curve is a theoretical chart of tax rates compared to tax revenues. It is said to have first appeared in 1974 when economist Arthur Laffer casually sketched the curve on a napkin for Republican leaders Dick Cheney and Donald Rumsfeld.

The Laffer curve hinges on three points: the tax rates at which tax revenues are zero and the tax rate at which revenues are maximized. The two known zero-revenue points are 0 percent and 100 percent tax rates. If the rate is 100 percent, no one would work because everything would be snatched away by government.

A graph of the Laffer curve starts at a zero tax rate and ends at 100 percent. The curve climbs from zero to the revenue-maximizing, or optimal, tax rate (for the government, not the individual); then it falls slowly down to the 100 percent point. The optimal rate (again for government) is the one at which people still have incentive to produce and invest but not enough incentive to risk evasion. That is the tax rate that returns the highest tax revenue. As rates rise to the optimal point, production continues to grow, but it gradually slows because all taxes are disincentives to earn. As rates shoot past the optimal point, production gradually contracts. The shape of the curve varies widely depending on who draws it because, in theory and in debates, the optimal rate can be any percentage in between the two extremes. (There is great debate about where the optimal rate falls, with some economists placing it at 15 percent, others at 70 percent.)

Laffer argued that taxable income is elastic; that is, taxable income changes in response to the rate of taxation because the two are dynamic. If tax revenue is maximized at X percent, then raising the rate any further causes people to lower their taxable income or to avoid paying. Thus, the rate increase lowers tax revenues.

Republicans are fond of pointing to a particular example that concretizes the lesson of the Laffer curve. In 1980 the top tax rate for high incomes was 70 percent. According to IRS records, total taxable income over $200,000 amounted to $36.2 billion, which generated tax revenue of more than $19 billion. When Ronald Reagan assumed the presidency in 1981, he cut tax rates in an effort to break a recession. In 1988 the top tax rate was 28 percent. According to the IRS, total taxable income over $200,000 was then $352.9 billion, which generated tax revenue of $99.7 billion. In short, tax revenues rose by more than 500 percent even though — or, perhaps, because — tax rates were slashed. When Republicans laud the Reagan years (1981–1989) as an economic “golden” period, they are largely referring to the return of productivity and prosperity that they ascribe to Reagan’s tax cuts. (Of course, as noted, more revenue to the government is not a sign of progress.)

Democrats dismiss the Laffer curve and prefer an ideological approach to the tax rate; that is, they use a standard of “economic fairness.” In his 2012 State of the Union address, Obama offered a sense of what he means by the term. He declared, “We can either settle for a country where a shrinking number of people do really well, while a growing number of Americans barely get by. Or we can restore an economy where everyone gets a fair shot, everyone does their fair share, and everyone plays by the same set of rules.” In short, so-called economic fairness involves the distribution of wealth by government from the wealthy to the poor; it is an economic leveling.

But what if a tax policy of so-called economic fairness reduces tax revenues? In 2008, when Obama was first campaigning for president, Charlie Gibson of ABC News pointed out to him that “in each instance, when the [capital-gains tax] rate dropped, revenues from the tax increased. The government took in more money. And in the 1980s, when the tax was increased to 28 percent, the revenues went down. So why raise it at all, especially given the fact that 100 million people in this country own stock and would be affected?” (Of course, if stock-owning individuals rather than government are viewed as the proper beneficiaries, then the proper tax rate is zero.)

Obama’s answer was enlightening. He admitted the accuracy of Gibson’s statements but concluded, “What I’ve said is that I would look at raising the capital gains tax for purposes of fairness.”

If redistribution of wealth is the goal, then a demonstration of how tax-hikes harm the economy will have no impact.

Leaving the United States is different from leaving one of the 50 states. The Obama administration has constructed a network of laws and treaties to prevent people or their money from escaping its tax authority. The United States is almost unique in taxing Americans on money earned in other nations; in other words, an American living and working in Mexico must pay taxes to both the Mexican and the U.S. governments. To keep Americans at home or abroad from hiding their money in foreign bank accounts, the administration has vigorously pursued laws such as FATCA (Foreign Account Tax Compliance Act). FATCA requires financial institutions around the world to report the presence and transactions of their American customers. Many banks are complying; many others are refusing to maintain American accounts; some are saying no. But the point remains: The United States is attempting to ensure that no taxpayers go missing, wherever they are.

But it is difficult for any government to overcome people’s sense of self-preservation and innovation. An “expatriate industry” is thriving with foreign-based lawyers and businesses guiding people on how best to leave the United States. The number of Americans who go through official expatriation channels, including the renunciation of citizenship, is still quite low. In 2011, the number was 1,781 — an increase of 16 percent from 2010; 235 renunciations occurred in 2008. Official channels can be very expensive, however, and no records are available on Americans who quietly leave or who simply never return from foreign employment.

The United States was born in a revolution against the imposition of taxes. If soak-the-rich measures proceed as planned, then the next revolution may be a quiet one that involves picking up suitcases rather than guns. When the most productive members of society leave, it will be a sure sign that the dream of economic and individual liberty now resides elsewhere. And the poor will suffer the most.

This article was originally published in the June 2013 edition of Future of Freedom.

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    Wendy McElroy is an author for The Future of Freedom Foundation, a fellow of the Independent Institute, and the author of The Reasonable Woman: A Guide to Intellectual Survival (Prometheus Books, 1998).