Tax the Productive
By Randall Holcombe • Friday June 11, 2010 12:47 PM PDT • 9 Comments
Hillary Clinton made the news a week or so ago by saying the rich don’t pay their fair share of taxes, echoing statements President Obama has made since his presidential campaign. But the remedy they recommend is to raise income tax rates on high-income earners. That’s not taxing the rich, it’s taxing the productive.
Rich people are people who have lots of wealth. People become wealthy by spending less than they earn, so their incomes can turn into wealth. But there is a difference between income and wealth. Someone can be rich — owning substantial wealth — without earning much income. Someone who has inherited a fortune, for example, but doesn’t have a job, can be rich but low-income.
Meanwhile, someone earning more than $250,000 a year (apparently, President Obama’s threshold for determining who’s rich) might have little wealth. One could imagine, for example, a heart surgeon who’s just finished her residency starting out with a high income, but little wealth, and maybe even negative wealth if she’s put herself through medical school by taking out loans.
If someone were really serious about taxing the rich, they’d advocate taxing people on their wealth, not on their incomes. For example, Bill Gates, and Warren Buffett, two people who have advocated higher taxes on the “rich,” both got rich not through earning high incomes, but on capital gains from the increases in the values of their companies. If Gates and Buffett were serious about taxing the rich, they’d say that rather than paying income taxes they should be taxed a percentage of their wealth they’ve accumulated.
I’m not advocating actually taxing the rich. I think it’s a bad idea. What I’m saying is that when people say the rich should pay more, they never advocate policies that actually would make the rich pay more. They advocate policies that would make high-income people pay more.
People’s incomes (much more than their wealth) come from their productivity, so when people advocate taxing the rich by increasing income tax rates, they’re not really advocating taxing the rich (because they’re not advocating a wealth tax), they are advocating taxing productivity. It should be obvious that increasing taxes on our most productive citizens is counterproductive.
People in government tend not to recognize how much risk there is in earning high incomes. They picture high-income individuals earning salaries just like minimum wage workers earn the minimum wage. They don’t see that those high incomes come from the people who earn them making risky choices. The entrepreneurship that drives our economy and gives us continual economic progress comes from those high-income risk-takers. Raising taxes on high income individuals will reduce entrepreneurship and slow growth.
President Obama and Secretary Clinton are not the only ones who confuse high-income people with the rich. Here’s a piece by the Tax Foundation attacking Clinton’s statement that the rich don’t pay their fair share. But the Tax Foundation too confuses the rich with high-income earners, noting that people earning more than $212,000 pay more than 40 percent of federal taxes. We can safely call those people high-income earners, but we have no evidence as to whether they are rich.
What we’re really debating, then, is whether productive individuals are paying their fair share, not whether the rich are. We need to make the distinction in public debate between “rich” and “high-income,” because they are not the same thing. The current administration is calling for higher taxes on the productive, not on the rich.
Tags: Budget and Tax Policy, Economics, Politics, Taxation, The State 
To start: hey, we’re on the same page: neither of us are advocating increasing tax on the rich.
1. A different objection to Hillary would be that she is wrong. The rich pay a disproportionate share of taxes however you measure it. About half of Americans pay no income tax. The richest 5% pay more than half of all income tax.
2. But sticking with your claim that people confuse wealth and income. That may be true, but practically, I’m not sure it matters. If I have $1B in wealth and I earn a measly 5% per year, that is $50m. That shows up on my 1040 as dividend and/or cap gain, but it all gets taxed. So wealth DOES get taxed. And increases in wealth get taxed (except when capital gain is not realized). It would be hard to measure wealth (especially unrealized cap gains). Today, we report gains and income...are you ready to report the balances in all your wealth-holding accounts? And what about wealth held for retirement? Wealth held in a health savings account? Wealth held in my primary residence? And estate taxes are wealth taxes. And your doctor...weren’t most of those loans she is struggling to pay back on her meager $250k salary subsidized and guaranteed by the government?
Again, I think point 1 is more interesting–that her premise (rich don’t pay enough) is flawed, not the subtlety of how we define rich.
Joe | Jun 11, 2010 | Reply
OK, so “the rich” are those with high net worth. Is the argument that they’re not productive? But what do they do with their money? As I understand it, they have three alternatives:
1) they spend it, which certainly contributes to the economy.
2) they invest it either indirectly in bank accounts stocks or invest it more directly, which also contributes to the economy
3) they hide it in mattresses, bury it in coffee cans, or put it in safe deposit boxes, none of which contributes to the economy, but since it’s hidden, you can’t tax it.
Am I missing something?
hanmeng | Jun 12, 2010 | Reply
Thanks for the comments, Joe and hanmeng. I agree with both of you.
Joe, I agree that with rare exception wealthy people are also high-income people. However, high-income people are not necessarily wealthy. So, higher tax rates on upper-income people will tax the rich, but also will place high taxes on some who aren’t rich.
I also agree, hanmeng, that the rich are also likely to be productive, if their wealth is used for investment. As Joe notes, that productivity gets taxed as capital gains, interest, and dividends.
But look at someone like Bill Gates, who when he ran Microsoft took a very modest (by CEO standards) salary and made his fortune on the appreciation of his Microsoft stock. During most of that time Microsoft paid no dividends, so he only paid capital gains taxes on the stock he sold as it appreciated.
I’m not saying Gates should have been taxed more. I’m saying that if we were proposing taxing the rich, we’d be proposing using the tax system to confiscate some of his wealth every year, along with the wealth of other wealth holders. That’s not what the current administration is proposing when they say they want the rich to pay more.
So, let’s have some truth in advertising here. How would we phrase it if we wanted to accurately portray the administration’s proposals? Would we say “I think people who are earning high incomes should pay more in taxes to help finance health care and other benefits for people who earn low incomes, or no incomes?” Is there a better way to phrase it?
We shouldn’t let the administration get away with misusing the language the way they are doing now.
Randall Holcombe | Jun 12, 2010 | Reply
I have a better way to phrase it. “We [the government] should steal more property from the people who earned it, take a nice cut for ourselves (theft is hard work, you know), and give the remaining loot to people that didn’t earn it in exchange for votes.”
Steve Hogan | Jun 12, 2010 | Reply