# Tax Thresholds: Why the horror stories about the Obama tax plan are lies

Watching news reports about President Obama's proposed tax changes,
I've seen a number of variations on a very annoying theme, which involves
a very stupid math error.

A typical example is this story on ABC news, which contains a non-correction
correction:

President Barack Obama's tax proposal -- which promises to increase taxes for those families with incomes of \$250,000 or more -- has some Americans brainstorming ways to decrease their pay in an attempt to avoid paying higher taxes on every dollar they earn over the quarter million dollar mark.

A 63-year-old attorney based in Lafayette, La., who asked not to be named, told ABCNews.com that she plans to cut back on her business to get her annual income under the quarter million mark should the Obama tax plan be passed by Congress and become law.

"We are going to try to figure out how to make our income \$249,999.00,"
she said.

"We have to find a way out where we can make just what we need to just under the line so we can benefit from Obama's tax plan," she added. "Why kill yourself working if you're going to give it all away to people who aren't working as hard?"

The original version of this article continued to follow this basic theme. The
updated article pretends to correct it, while still basically mantaining the
same focus.

The idea behind this, and similar stories, is that raising the income tax
rate on people earning over \$250,000 per year creates a threshold, where earning
more than that threshold will result in your taking home less
after-taxes pay than if you earned less.

How could that happen? (I'm making up nice round numbers here to illustrate;
these have no relation to real tax rates.) Suppose that the tax code was set up
so that if you earned less than \$250,000, you paid 20%; and if you earned more than \$250,000 per year, you paid 30%. Under that system, if you earned \$249,000 per year,
you'd pay \$49,800 in taxes, for an after-taxes take-home of \$199,200. If you earned
\$251,000, then you'd pay \$75,300 in takes, for an after-taxes take-home of
\$175,700.

So if taxes actually worked this way, then there would be a range
of incomes where there would be a strong motivation to keep your income
smaller, in order to avoid crossing the threshold - because earning more
would translate to earning less after taxes.

The ABC story, and all of the others I've been seeing/hearing have either
implied or directly stated that that's how our tax system works - and that therefore
people earning close to \$250,000 are frantically searching for ways to keep their income
below the horrible \$250,000 threshold.

The problem is, that's not how our tax system in the US works. Anyone who
pushes this story is either too dumb/uninformed about how US income taxes work
to be commenting on it, or they're liars.

The way that the US system works is that there's a base rate of taxes. You pay
the base rate on all of your income up to a threshold. When you cross that threshold,
the tax rate on the part of your income above that threshold is
increased. The Obama proposal is to add a new threshold: the tax rate on the
part of your income above \$250,000 would be increased - not the
tax rate on the entire thing.

To go back to our example, imagine that \$250,000 was the only threshold,
and that the base tax rate was 20%, but that the rate on income above \$250,000
was 30%.

If your income was \$249,000, then your tax bill would be the same - \$49,800,
for a take-home of \$199,200. If your income was \$251,000, then you'd
pay 20% on the first \$250,000, and 30% on the \$1,000 above \$250,000. So
your tax bill would be \$50,000 + \$300 = \$50,300 - for a take-home
of \$200,700. Of your extra \$2,000 in income, you'd take home \$1,500 - or 75%.

This story is a lie, plain and simple.

As usual, I'm trying to avoid the politics of this as much as possible. It's
possible in good faith to think and argue that people earning more than \$250,000 per year
are taxed too much; it's also possible in good faith to think and argue that
people who earn more than \$250,000 aren't taxed enough. You can make a reasonable
argument that raising taxes on those people will hurt the economy; you can make
a reasonable argument that raising taxes on those people will help the economy.
For the purposes of this post, I'm not taking either side on whether the proposed
high-income tax-hike is a good idea or a bad idea. But this threshold argument
about how people need to keep their income down in order to avoid getting screwed
by the hike isn't a reasonable, good-faith argument. It's a lie, and even the
most rudimentary attempt to check if it makes sense would show that it's transparently false.

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I don't know if this is a lie so much as simply incredibly sloppy reporting. I've heard this same misconception many times from people about how the tax system works. It is possible that the reporters were under this misconception and then did zero fact checking.

people earning close to \$250,000 are frantically searching for ways to keep their income below the horrible \$250,000 threshold.

MarkCC, I don't think you understand the disincentive that high marginal tax rates generate. Because, this is a big issue.

If a brain surgeon can work 6 moths per year and take home \$X, or work 10.5 months a year and take home \$X*(6.5/6), why would she want to work the extra time for the diminishing returns? If she's taking home \$0.30 for every \$1.00 of fees she charges for the last 4.5 months of work, why not take a break? Spend time with the family. Go on a cruise.

After all, this will reduce the supply of brain surgeons, and push the fees she can charge *up* next year, letting her work even less next year.

But, consider, her staff is now working half time now. Billing, appointments, nurses, etc.

Less employment for all. That's the story.

I'm not taking either side on whether the proposed high-income tax-hike is a good idea or a bad idea

But I think I know where you stand, as it isn't exactly a secret where your political sympathies lean. But in time you'll learn how wrong you are.

The most scary aspect of a person like Obama and his toadies is they have power. And nothing is scarier than law and order liberals wielding real government power after they realize their silly ideas fail in reality.

By William Wallace (not verified) on 05 Mar 2009 #permalink

William, you miss the point that Mark is making. I'm sure Mark understands diminishing marginal returns and the impact that can have. But that's not the issue being reported on the reports. They are simply getting the basics of the tax system wrong in a way that makes the planned tax increases seem much worse.

@William Wallace

We in the reality based world like to see empirical evidence when claims are made. While I was "highly impressed" with your explanation of how raising marginal rates is a huge disincentive towards productivity, I would still like to see the statistical evidence that that's indeed how it plays out in practice.

If she's taking home \$0.30 for every \$1.00 of fees she charges for the last 4.5 months of work, why not take a break?

LOL! At least Mark's made up tax rates resembled real tax rates.

Re #2:

William, I do understand the idea of decreased marginal returns. But that's *not* what the various arguments I'm criticizing are talking about: they're talking about tax changes causing increases *gross* income to produce *decreases* in net after-tax income.

I'm also very skeptical of the idea that small tax changes really have a serious effect. Do you really believe that raising the incremental rate from 35 to 37% is going to be enough to discourage anyone from working? Seriously.

As for the scare tactics... This is something that I really want to know. Do you *really* consider liberal political policies *scarier* than the astonishing power-grabs during the last 8 years? Are liberal policies really more scary than
a president who claims the power to declare people as "illegal combatants" and detain them indefinitely without evidence and without trial? Are they really scarier than a president who claims that he has the right to ignore any law he doesn't like? Are they really scarier than a president who claimed the right to suspend the first amendment?

William Wallace == famous troll

Too bad he had to throw in a dig about your supposed politics, when in fact the post had nothing to do with it. IMO, the disincentive to work harder and make more couldn't possibly be related to the tax rate differences. I mean, really?!? Who would truly want to make less just to avoid paying *more* taxes? Do you live in a shack in a terrible part of town just to avoid paying higher property taxes? Methinks no. NO ONE thinks that way, therefore if a disincentive exists, it must be related to something more fundamental.

Of course, it's possible Mr. Wallace lives in a shack and only takes/uses cash. That seems consistent with his views.

Re #6:

I actually disagree with you. I think that there *is* a disincentive associated with higher taxes and diminishing returns. But it's not as straightforward as William would claim.

I see it as very much like the Laffer curve. If you aren't familiar, it's a curve that demonstrates how decreasing taxes can actually increase revenue. The idea is that as tax rates increase, less and less money is available for investment, which reduces the amount of taxable income, which reduces revenue. There's a threshold point where you've reached the maximum effective tax rate - where increasing it any further puts you into the range where you'll collect less revenue even though the rate has increased.

I think there's a similar phenomenon with personal taxes. At some point, the incremental benefit of more income becomes smaller than the amount of work that must be performed to gain that benefit.

Just like with the Laffer curve, the question is, where's the threshold?

If you look at the Wall Street Journal editorial page, we're *always* in the downward range of the Laffer curve - that is, no matter what tax breaks we give to business and investment, they'll always claim that we're still in the diminishing returns range, and if we reduce taxes more, we'll see more revenue.

People like William are essentially making the same claim: *any* increase in taxes will inevitably result in people refusing to work, because they won't see enough of the benefits of the additional work.

Personally, I think that the threshold for personal taxes is a lot higher. If you make a change so that for every additional dollar I earn, I take home 65 cents instead of 70 cents, that's not going to stop me from working more. On the other hand, if for every additional dollar I earn, I take home an extra 10 cents, there's a good chance that I just won't bother.

I don't know where the threshold is. I know that it's frustrating to see how much of my paycheck goes to taxes, and I'm not overjoyed at the thought of seeing *more* of it taken away. But I don't think that we're anywhere close to the range where there's a real, serious disincentive to work.

William,

Other commenters, including Mark, have pointed out that you missed the point in the bog post. I'd like to point that you miss the point in Mark's entire blog.

You provide an argument that seems reasonable and may or may not be fallacious. I may not agree that, as Mark points out, that an increase in the taxation of that particular income band will reasonably lead to highly paid professionals reducing their work load. even if I assume that it will happen, I cannot assume that it would lead to further economic downturn, since the void left by their work withdrawal will likely be filled by other less experienced and less paid professionals and will open up highly restrictive fields to newcomers.

But I can't claim to understand macroeconomics nearly enough to have a well formed opinion about the outcome of the proposed tax hikes. And, as the last paragraph of the post rightly puts, one can make a reasonable argument either way. What one cannot make is a blatant attack on mathematical reasoning and try to spread it as fact to a population that will not verify whether or not the claims are sound.

People may have any political beliefs and tendencies as they please, if their statements are mathematically incorrect, their statements are completely incorrect. And no amount of ad hominem arguments against the poster will change that.

"I see it as very much like the Laffer curve. If you aren't familiar, it's a curve that demonstrates how decreasing taxes can actually increase revenue."

Sorry Mark, but the Laffer curve has no basis in reality. It fails logically - there is no reason to justify the relationship being as simple as the curve implies, or to rule out the possibility that other factors have a huge influence on the relationship between taxes and revenue.

Your original post is great - but the laffer curve idea deserves to be sent back to where it's been: the dust pile of non-relevance.

I thought there is a threshold (pretty high) where the tax changes to taxing the whole amount instead of the marginal amount, but at the same time the rate is dropped appropriately so that the net after taxes for \$1 over the threshold is still larger than being \$1 below it.

Even so, while the marginal rates themselves will not produce a smaller net for a larger gross, there are plenty of other traps in the tax code that will. Particularly thresholds that disallow various deductions, I've been encountering those more and more as my income has grown overtime. What's frustrating is that while it has been growing because of performance, a lot of it is just simple inflation; I am not all that much wealthier than I was, yet inflation has pushed me over these thresholds increasing the proportion of tax I owe. Nothing to do with your article, just felt like venting a little.

Sorry Dean, the Laffer curve does not fail logically. If people are saying they are going to limit their income to avoid paying more taxes, then the Laffer curve is demonstrated. The problem with the Laffer Curve is that it is impossible to say what the shape of the curve is exactly, and for that reason it fails, not that it is inherently contradictory. There are only two points on the curve that are well defined, 0% tax rate and 100% tax rate, at both the expected revenue is zero. Since revenue will be positive for any other tax rate, it has to be the case that some tax rates will have a positive slope and some a negative slope. Where those slopes are, though, is a mystery. And that is what makes the Laffer Curve true conceptually, but useless practically.

Re: the Laffer curve, I doubt that any of us (conservative, liberal, or even many radicals) would want to live in a society whose government taxes its citizens' income at a rate of 100% (i.e. at the right-most extreme of the curve) â even if that government compensates them via redistributive programs. But that's a very different argument (of an ideological kind, probably shared by most of us raised in real-world capitalist countries) than the empirical claim that such a government would necessarily make 0 revenue. What basis, if any, is there for such a claim? or is the Laffer curve itself an ideological expression posing as a scientific theory?

@The Laffer Curve

What defenders of the Laffer Curve always conveniently leave out is what happens to the tax revenue. One of the reasons that we don't see Laffer Curve type data in real economies is that nations with high tax rates tend to pump that money right back into the economy in the form of business/agricultural subsidies, infrastructure spending, healthcare, etc. Tax revenue doesn't go down for the same reason that heavy evaporation doesn't cause sea levels to go down.

Sorry Mark, but the Laffer curve has no basis in reality. It fails logically - there is no reason to justify the relationship being as simple as the curve implies, or to rule out the possibility that other factors have a huge influence on the relationship between taxes and revenue.

I think most people would agree to the following:
1. If the government set the income tax rate to 0% it would get no income tax revenue because no one would have to pay taxes.
2. If the government set the income tax rate to 100% it would get no income tax revenue because no one would work.

If you accept the above two points, than it follows from Rolle's Theorem that there must be some point in the range (0%, 100%) that results in maximum revenue. If your tax rate is beyond this point then reducing it to that point would necessarily increase total revenue.

In that sense, the Laffer Curve is logical.

Where the problem is in the application to the actual tax system, where people assume 1) we are necessarily to the right of that point or 2) that the shape of the curve is such that incremental reductions will lead to increases in revenue (e.g. if the optimum tax rate is 50% and we're at 60%, a reduction to 55% may not increase revenue just because a tax rate of 50% would).

Another problem with the Laffer Curve is that it's based on the assumption that the primary goal of tax policy ought to be maximizing government revenue, whatever the other effects of that decision are.

Re #12:

Ding! Ding! Give that man a prize!

Yes, the Laffer curve is nothing but ideology wrapped up in pseudo-scientific terms.

The basic idea behind it is simple - as I and others have pointed out, the basic idea is that somewhere between taking everything (which stops anyone from producing anything), and taking nothing, there's got to be a maximum.

Laffer takes that, and asserts that it's a simple curve with a single maximum. Supporters of Laffer constantly assert that we're
past that maximum point.

But if you think about it, the number of assumptions contained in the statement that it's a simple single-maximum curve is absolutely astonishing - and absolutely ridiculous. But if you acknowledge the fact that the *real* Laffer curve - the real curve of government revenue plotted against tax rates - is incredibly complex, then the whole Laffer argument goes out the window. It only really works at
extreme points; if the government taxes income at one half of one percent, they're not going to get much revenue; and if they tax income at 99.5%, they're not going to get much revenue. But once you pull away from those extremes, the Laffer curve tells you nothing.

Don't a lot of the people who make more than \$250,000 per year get a salary? Their pay is not contingent on the work they do at any specific moment, so they wouldn't really have any reason to stop working just before the quarter million mark, even if taxes did work they way the reporters seem to think.

If you look at the tax rates historically you will find that during the greatest period of corporate growth and investment in the USA there were incredibly high marginal tax rates on the highest income levels.

The highest rate was 90%, which only affected one person when FDR implemented it, his own vice-president. But all through the 1940, 50's and 60's there were marginal tax rates into the 70% and higher.

Now, did the government get much additional income from this incredibly high marginal rate? No.

What it did was provide a disincentive for people to be paid too much money. Why would an executive, movie star, athelete want to be paid so much that Uncle Sam took 70% of their additional earnings?

But the money was still entering the corporations, movie studios, sports arenas, etc. So the companies did other things with it other than executive compensation. They invested it in R&D, they provided health care and pensions for their employees, they paid it out in dividends and shareholders spent it.

As far as I'm concerned, we shouldn't worry about trying to legislate an executive salary cap, we should learn from what worked in the past and apply a 90% marginal tax rate, say at a \$2,000,000 level these days, and you will quickly see top salaries drop to that level.

Even if the government doesn't get one penny from this marginal rate, the additional circulation of cash will help keep the economy stable.

My \$0.02.

Flex

Steve M wrote: "There are only two points on the curve that are well defined, 0% tax rate and 100% tax rate, at both the expected revenue is zero."

The application of marginal tax rates means that this particular incarnation of the laffer curve is clearly not symetric. If there was a 100% marginal tax rate, at say \$400,000,000 and above, it would not make a difference in tax revenue at all. The same amount of taxes would be collected because no one has an income level that high.

To make the laffer curve work on a tax collection side of things you pretty much have to postulate a flat tax. The curve is a nice little model for the demand of goods and services which may have a percentage-of-sales tax or a flat-rate tax (both are flat taxes), but terrible as a model for marginal tax collections.

Mark, maybe it's time for a post explaining the Laffer curve. And how a simple and obvious truth can be distorted and used to legitimize propaganda.

Also, some people will work overtime even if the marginal tax rate is 100% or higher. Not many though.

\$250,000 doesn't simple salary with a standard deduction. There is AMT too, as well as deferred compensation and all sorts of creative deductions. In some professions, e.g cosmetic surgery, there is a simple matter of raising your rates to compensate for the tax hit.

This is a great time to get stock options. Prices are low, and when they mature in 5-10 years, we'll probably have a new administration...

Obama's tax plan will create more business for the tax lawyers and accountants.

On the heels of #16, perhaps I'm just a happy-go-lucky guy, but I really can't relate to the whole issue. I work because:

a) I have to in order to afford the lifestyle that I desire; and

b) because I derive some (often unexpected) psychological benefits from the work that I do (e.g. it sometimes gets me into a creative flow and forces me to socialize more than I might otherwise).

In other words, targeting a particular income tax bracket is the last thing on my mind when I plan and enact my career. So, the suggestion that I would work less if government taxed my income at a higher rate strikes me as counter-intuitive, to say the least â but then I suppose Mark is right that the issue only makes sense at the extremes (i.e. near 0% and 100%).

If you accept the above two points, than it follows from Rolle's Theorem that there must be some point in the range (0%, 100%) that results in maximum revenue. If your tax rate is beyond this point then reducing it to that point would necessarily increase total revenue.

As was noted before, the maximum need not be unique, so even this version of the argument is problematic.

I'd say the bigger theoretical problem with the Laffer curve is that it models revenue as a function of a single variable, and treats that in isolation. Any reasonable model of revenue depends on multiple variables; if maximizing revenue is actually the concern, then approaching the question using one-variable calculus (with a specially-selected variable) is highly disingenuous on the part of the Curve's proponents.

"...Why the horror stories about the Obama tax plan are lies"
This post is great and it addresses well a possible misconception in the US federal income tax code, but the title has some extreme hype or it's simply deceptive. I've never heard serious criticism, let alone a 'horror story,' about tax bracket evasion. Instead, I've heard about limited itemized deductions, capital gains tax, reckless spending, the general adverse affect on the bottom line, brain drain, etc. Also, Mark's characterization in #5 of the Obama tax plan as a 2% increase on a single tax bracket is under-exaggerated.

Anyone who characterizes Obama's taxation horror stories with this example is either too dumb/uninformed about tax proposals to be commenting on it, or they're liars.

(^^I couldn't resist. I've seen that line before on this blog and I think it's a bit too harsh no matter who the subject is.)

Re#6: Mark has been perfectly up-front about his political persuasions (along with many other personal details). William Wallace did not make the reference as a dig towards Mark. The case is just that many of us free-market thinkers are stunned that someone who knows math well like Mark would entertain such radically different viewpoints. And we mention it because this post comes from the direction of Mark's politics.
A creationist speaking about a minor gaffe of an evolutionist in defense of creationism would provoke similar criticism of his/her underlying views.

Then, multiple commenters have said there is no empirical evidence relating to the Laffer curve. That's ridiculous. All over the world governments are performing economic experiments, and they all contradict the staunch American Liberals here. Just consider China's special economic zones.

Oh, and the Laffer curve is only pseudo-scientific if supply and demand curves are.

I think the bigger question is: Will the brain surgeon use his money in a more productive way than the government? My opinion is, yes he will... if only because he is more likely to have a vested interest in the growth/security of his own money.

Re #23:

I quoted the specific story that I'm criticizing. There's plenty of reasonable reasons for people to be upset about a tax increase. But this idiotic argument has been popping up all over the place lately, and it's stupid, so I wrote about its stupidity. And yes, anyone who's telling this story about people desperately trying to keep their income below \$250,000 in order to avoid the supposed tax penalty is either stupid, uninformed, or a liar.

As far as the Laffer curve goes - it's a joke. As I said above - it's based on taking an extremely complex phenomenon, and describing it with an artificially simple model in order to support a pre-determined argument. In the real world, when you look at real data, you can't find anything that looks like a Laffer curve.

Finally, I always find it hysterical when someone brings out China as an example of something like this. The Chinese economic system is a bizarre hybrid of capitalism and communism, with information tightly controlled by a bunch of
censorship crazy government bureaucrats. In reality, we know very little about what really goes on in the real Chinese economy. All we *really* know anything about is their exports. Their "enterprise zones" are a showcase - and we don't really know whether they're a real capitalist success story; a government run set of businesses operated by virtual slave labor; or a totally fake Potemkin village.

If China is the best you can cite to support your argument, your argument is in pretty poor shape. I mean seriously, what would you say if I were to write a post about the glories of communist economies, citing the success of China as an example?

Re [#4] and [#6]. See marginal tax rates under President Carter. [#4] If anything, my example was overly optimistic, considering the money for insurance brain surgeons have to shell out.

[#5]But that's *not* what the various arguments I'm criticizing are talking about

Understood, but yours is a small matter. And you have a tendency, it seems to me, to find math problems when the math is being used and abused as an argument against liberal agendas. I could be wrong. If you have some posts where you complain about bad math being used against conservative agendas, refresh my memory.

And, in any event, this journalistic confusion about taxing is a small matter compared to the bad math being practiced by those with actual and immediate political power.

Do you *really* consider liberal political policies *scarier* than the astonishing power-grabs during the last 8 years?

I said that I consider liberals with power dangerous after they realize their silly ideas don't work. History provides ample evidence of this.

But to address your point, it was FDR who put U.S. citizens in internment camps. And not just one or two, as Bush did with Padilla.

But don't think that means I supported the creation of the TSA, the passage of the Patriot act, or the invasion of Iraq. I was against them all, before they were implemented, based on conservative principles. Many of my colleages who think they are conservative but are really just fans of politicians who claim to be conservative were annoyed by my rants against invading Iraq. (Now, they act as though they always knew it was a bad idea).

Regarding President Bush, don't confuse the radical president who happened to get elected as a Republican with the idea of a Conservative President.

A real conservative sticks to his principles even when the outcome is not personally desirable. Take, for example, Justice Clarence Thomas, who recently sided with states' rights in the Supreme Court case dealing with medical marijuana. That is how conservative leaders behave.

Are they really scarier than a president who claimed the right to suspend the first amendment?

We will see how President Obama deals with the first amendment as time passes. And, I think I have reason to be concerned.

Regarding many of the other comments, many of you, who do get at one level the possible deleterious consequence of high tax rates, seem to think that we should set the tax rate to maximize government revenue. This is your liberal bias at work.

You view a government with maximum revenue as a good thing.

The purpose of government is not to maximize its revenue. It is to protect our freedom. Government should only be funded to the extent necessary to achieve that goal, within the bounds of the Constitution. Whether the government revenue function looks like a plateua, a triangle, or a quadratic is of no concern to me. I don't care about maximizing government revenue.

The argument against higher marginal tax rates is that it lowers economic productivity, and the ability of those who are not rich to get rich. Paradoxically, at least from a naive perspective, it is, in my experience, the very wealthy, and most especially, the old money, who like high marginal tax rates. It prevents the peasants from getting rich. When Reagan started cutting marginal tax rates, the number of millionaires and billionaires, new money, exploded.

And what do the new rich do? Things that the government does not. For example, the Davidson family founded and funded the Davidson Institute, providing free programs and support for profoundly gifted students. The government? It provides free programs and support for average and below average students, and throws the smart ones under the bus.

For example, rather than use our money wisely, and have a class for deaf students, schools are forced to mainstream deaf students, and hire an individual sign language interpreter for one student, who follows her from class to class--as though that better prepares her for life in the real world.

Meanwhile, some schools cut gifted programs because their is no mandate, and other schools cut them because they believe that gifted students help poorer students.

Regards,

WW

By William Wallace (not verified) on 05 Mar 2009 #permalink

Our posts crossed, but I have to comment:

I mean seriously, what would you say if I were to write a post about the glories of communist economies, citing the success of China as an example?

China is communist in name, but is arguably operating in a more capitalistic mode than the U.S. right now. I personally think they (the communist party leadership there) are just being pragmatic, and this capitalistic era is temporary and strategic. But the fact is they are thriving, and one of the reasons is they are pursuing economic freedom more than we do in the U.S. (Another is free trade, selling the U.S. trinkets.)

I am not sure where you get your information about China, but a very good friend of my family was doing as well as anybody under communism--that is, eating grass soup during the great leap forward--but now he's wealthier than me, and perhaps you, thanks to his ability to build high rises (in a part of china not often mentioned in the west). Indeed, one of my college professors from China, wealthy by American standards (\$250/hour consulting fees, business, wife is an M.D.), regrets not staying in China, like his brother did, and getting even wealthier, like his brother did.

I went to China in 2000, and I was impressed even then at the burgeoning middle and upper classes, although at that time it was really just beginning.

By William Wallace (not verified) on 05 Mar 2009 #permalink

I will make one other comment, which I hope is cogent, to the Laffer curve discussion:

Regardless of the shape of the curve--simple, complex, etc.--there is an additional point often missed: it is likely a time-varying curve, not a static one.

Which makes it even more useless as a real-world model on which to base tax or other monetary decisions.

By OutofMyMind (not verified) on 05 Mar 2009 #permalink

Correct me if I'm wrong, but China's top marginal rate and capital gains rates are higher than ours here. It doesn't seem like a 45% top marginal rate is throttling their growth too badly.

But I suppose that this could simply be an illustration of why comparing one variable between two countries with spectacularly different economic systems and levels of industrialization is a silly thing to do. One might just as well say that the growth is due to their higher soybean consumption.

By Troublesome Frog (not verified) on 05 Mar 2009 #permalink

Mark, I lived and studied in China.
You are completely ignorant about China and you even try to project that onto others.
And I mean COMPLETELY ignorant. Would you cite Hong Kong as an example of communist success? And what about China's special economic zones are communist?
What you're writing is laughable.
I don't know what else to say. If you knew much about the Far East you wouldn't be so quick to poo poo economics.
It's ignorance about other cultures and chauvinistic statements like in #25 that give Americans a bad reputation.

It seems bizarre that people don't understand marginal tax rates. However, it seems the article is literally correct: "President Barack Obama's tax proposal -- which promises to increase taxes for those families with incomes of \$250,000 or more -- has some Americans brainstorming ways to decrease their pay in an attempt to avoid paying higher taxes on every dollar they earn over the quarter million dollar mark." That doesn't prevent people from acting irrationally (against their own self-interest) to prevent what they perceive to be injustice. It reminds me of the experiments described in the book "Sway" where people rejected free money because they perceived they were being treated unfairly and had a chance to deprive the person treating them unfairly of free money. Particularly in the case of the person described in the article, someone who can presumably lower their income to less than \$250,000, they aren't making enough over \$250,000 to make the extra 2% have a significant impact.

I think the progressive tax system is unfair because it doesn't consider the variable cost of living expenses incurred in different regions of the country. That doesn't mean I am going to move to an area of the country that I don't like.

By Matt McKnight (not verified) on 05 Mar 2009 #permalink

Since when is fact checking of news stories a priority for most "reporters" in the "mass" media? All that matters is the next highly rated sound bite, isn't it?

Speaking as someone who lives in a country (the UK) where the main marginal tax rate (which pushes the tax rate from 30% to 40%) kicks in at about Â£28,000 per annum (or about \$40K), you'll forgive me if I snort in derision about people complaining about a marginal tax rate that kicks in at a quarter of a million bucks a year.

I simply don't believe that anyone who is capable of earning over that amount of money is stupid enough to not understand that the higher rate of taxation is only on the money above that amount. And if they are that stupid, well, frankly, they are being overpaid.

I don't now what the actual sums being suggested are, but let's do a little sum. If we assume that someone is being paid, say, \$350K per annum, and the marginal increase is an extra 5% over \$250K, we're talking about an extra \$5000 tax in a year. That's actually an extra \$14 a day tax for someone who is being paid (gross) about a grand every day. Well, forgive me if I'm not sympathetic. And the average guy in the street, who can only dream of a quarter of a million bucks, won't be all that sympathetic either.

As someone who pays 63% on some of my income, I find the angst of US tax payers somewhat baffling.

Regarding the Laffer curve - it's not really relevant, as it's dealing with the overall tax revenue, and there is no way in hell that Obama's very moderate tax increase will reduce the overall tax revenue. Even if people start working less (and as Mark pointed out, there is no reason why someone would want to do that), there will be others to pick up the work, and thus pay taxes.

WW wrote, "The argument against higher marginal tax rates is that it lowers economic productivity, and the ability of those who are not rich to get rich. Paradoxically, at least from a naive perspective, it is, in my experience, the very wealthy, and most especially, the old money, who like high marginal tax rates. It prevents the peasants from getting rich. When Reagan started cutting marginal tax rates, the number of millionaires and billionaires, new money, exploded."

You make three claims in this paragraph.

First, that higher marginal tax rates lower productivity. Our historically highest marginal tax rates for the wealthiest group were within the decades of the 1930-1960s, which corresponds to our highest level of productivity, if you consider the expansion of the US economy as an increase in productivity. There are, clearly, additional factors surrounding this expansion, but you appear to claiming that productivity would have been higher over that period had there not been a 90% tax bracket. Show us the evidence.

Second, you claim that the wealthest people, with old money, prefer a high marginal tax rate because it oppresses the rest of the population. You call this a naive perpective and I'd agree with you. While I can accept that some of the ultra-wealthy people may have felt like Judge Smails in Caddyshack, if you look at the number of uber-wealthy people and families during that same period, 1930-1970, you will find that there were fewer and fewer of them. That population of American aristrocrats was shrinking. Their opinions are irrelevent.

Third, you claim that when Reagan cut the highest marginal tax rate from the upper 50% range (IIRC) to 38% a lot of millionaires were created. I'm not convinced that lowering the highest tax rate had much to do with the creation of millionaires. In my analysis, the deregulation of the banking and credit industry and the deregualtion of the stock market had a lot more to do with the creation of the new millionaires.

Further, why is the creation of new millionaires and billionaires a good thing? We have seen that the trickle-down theory doesn't work. The money that these people accumulated did not flow back into the economy, that's what accumulation means. That's why they are millionaires, they didn't spend everything they received.

Finally, I agree with you (which you may find surprising for a card-carrying democrat) that the purpose of government is not to maximize tax revenue, but to provide the services required of it. I suspect we would disagree about the level of service required, but that's a minor point in this discussion.

The only reason I think so many people are worried about how to maximize government with a minimum affect on the economy is because its pretty clear that servicing the national debt is becoming a drag on the economy as a whole. As Keynes suggested, we should have paid off government debt when the economy was booming, so we would be able to acquire government debt when the economy went bust.

The government, through its regulations on business and ability to acquire debt can mitigate the effects of the business cycle (boom and bust) on the health of the state. Since 1982, with both the degregulation of business and the acquisition of a tremendous debt load, the ability of the govenment to mitigate the boom and bust cycle is tremendously decreased.

I used to work with a medic, who refused to work beyond a certain amount of overtime per pay period. He insisted that the fallacy you describe in the post is the way the tax system works. I was always happy to take the overtime for 2 reasons. I could use the money and he was not any better as a medic than he was at math.

One of the changes that will happen with increasing tax rates is not just income avoidance, but tax avoidance. As the rates increase it becomes worthwhile to spend more on tax attorneys and tax deductions, than it would at lower tax rates. Even if it is only an imagined benefit to do so, some people will divert money this way.

With higher rates of tax it becomes more likely that it will be cost effective for a person to use tax avoidance measures. Such as domiciling overseas or even going into tax exile. While extremely inconvenient for most people the very rich (and certain other groups such as merchant seamen) can do so with relative ease. During the 1970s the UK had a top rate of income tax of 83% with a surcharge on unearned income that raised this to 98%. This meant that for high earning tax exiles like the Rolling Stones their world tours missed out the UK as it would have resulted in a tax bill on the whole of their annual incomes which would far exceed the income earned from concerts in the UK.

By Brett Dunbar (not verified) on 06 Mar 2009 #permalink

WW wrote,

and the ability of those who are not rich to get rich. Paradoxically, at least from a naive perspective, it is, in my experience, the very wealthy, and most especially, the old money, who like high marginal tax rates. It prevents the peasants from getting rich.

This is a statement not based in fact. There are studies that show that growing income inequality hinders economic mobility, not high marginal tax rates.

The charts in the back of the tax booklet that 'everyone' used to receive every year listed the tax owed at various income levels. The way that chart is (was?) laid out makes it very easy to *assume* that the tax rate for _your entire income_ is the same for every dollar of that income. The chart suggests that, for example, if your income is between \$10,000 and \$11,000 your tax is \$100, but from \$11,000 to \$12,000 your tax is \$111 - so someone earning \$10,999 would have more after-tax income than someone earning \$11,001. (A difference of nine important dollars!)

During the early reign of Ronald Reagan I was in the very odd position of 'having to pay' approximately \$70 more than I would have if I had worked seven minutes less that year (I was paid by the hour). That was when I found out that those tables were _not an accurate reflection of the actual tax code and how tax rates change with income_. (I do not remember if I actually received a refund that was \$70 less than what it would have been if I had worked seven minutes less, but my recollection is that the refund check was for the amount I had calculated using their tables.)

So, the way that a lot of people talk about taxes is, at best, inaccurate....but many people over thirty have calculated their taxes every year based on a chart that - while simple and 'user-friendly' - does not accurately reflect tax laws or tax rates and which facilitates their making exactly the kind of error you wrote about.

By Christopher Gwyn (not verified) on 06 Mar 2009 #permalink

It is amazing how out of touch liberals are, both with current times and U.S. history.

Take for example, Ken Davis, of Ken Davis BBQ sauce fame, who was struggling for many years trying to sell his BBQ sauce in Minnesota. He would sell it door to door, at super markets, and even stopping in at bars, selling it out of the back of his station wagon.

In the 80s, it really started taking off--thanks, I believe, to lower tax rates (and the end of higher Jimmy Carter interest rates). With an ability to keep more of his profits, he was able to grow his business faster.

Of course, liberals don't like it when African Americans escape the liberal plantation of government programs. Better to keep them on food stamps, liberals think.

And liberals think it is a bad thing when people who are not wealthy become millionaires, as evidenced by some of the posts on this blog entry.

Start naming the new millionaires and billionaires that came into existence in the 50s, 60s, and 70s. As for billionaires in the U.S., I believe you will find exactly 0. I think you have to go back to the early 1900s or late 1800s.

But this is a good thing, according to some of you. We should not be creating new millionaires. We should be rejoicing when their numbers dwindle. Whatever. When is the last time a poor person gave you a job?

Fortunately for Ken Davis's widow, their business is still family owned. At least until the liberals take it away in the name of government programs made necessary by liberals in the first place.

As for the current capital gains taxes in China, they are, from what I understand, and contrary to what some of the liberal apologists here are asserting, very low to none-existent. Indeed, see China Scraps Tax on Stock Gains for Foreign Investors.

Strange that Obama and his friends here want to out-tax the "communists".

As for brain Surgeons...anybody here qualified to take up the slack when the \$600,000/year brain surgeons decide enjoying life with their families four months extra each year is worth more than the additional \$50,000 they will make if the big government taxation crew gets its way?

Didn't think so.

And, you will also see, then, that the receptionists, billing agents, nurses, etc., have their hours cut, and you may, if you think about it, begin to realize that money really was trickling down after all.

By William Wallace (not verified) on 06 Mar 2009 #permalink

William, that's a whole lot of strawmen.

Did anyone here say that it's a bad thing for people to become millionaires? No.

Did anyone here suggest any of the things you're saying? No.

Has anyone anywhere in the Obama administration, or the
Democratic party, or the any of the liberal political organizations every suggest anything like any of the stuff that you're saying? No.

As usual for you, you're just making shit up. Liberals are the root of all evil. Liberals hate people who make money. Liberals want to take everything away from you. Liberals want to take away your free speech. Liberals are out to get you at every turn, and in every way.

Except that it's a load of bullshit, and you know it as well as I do.

The subject of this post was a stupid way that people misunderstand the US tax system. You responded with a strawman about how people are going to stop working if their taxes go up. Of course, you can't provide *any* evidence for that - because historically,
there's never been a time in the US when people have stopped working in order to avoid taxes.

You keep talking up how great China is. And yet, China is, overall, an incredibly poor country with a repressive authoritarian government that doesn't allow any independent reporting on their economy. But when it's China, and it looks like it might support your argument, suddenly the Chinese government is the peak of trustworthiness, and a shining example of how well free-market system works - at the same time railing against the awful things that the liberals are supposed going to do to take away your freedoms.

Do you have *any* actual argument? Or are you just going to sit there spewing out endless cascades of strawmen?

In the 80s, it really started taking off--thanks, I believe, to lower tax rates (and the end of higher Jimmy Carter interest rates).

You believe? Personally, I correlate it with Brunei becoming an independent state. Or do you have some actual data for this that explains your reasoning?

Of course, liberals don't like it when African Americans escape the liberal plantation of government programs.

Are you for real? Do you always assume that everybody who disagrees with you is simply evil for evil's sake?

As for the current capital gains taxes in China, they are, from what I understand, and contrary to what some of the liberal apologists here are asserting, very low to none-existent. Indeed, see China Scraps Tax on Stock Gains for Foreign Investors.

You're still not addressing two important points:

1) This post is about the top marginal income tax rate.
2) China has a higher top marginal income tax rate than we do, and it doesn't seem to be strangling their growth at all.

As for brain Surgeons...anybody here qualified to take up the slack when the \$600,000/year brain surgeons decide enjoying life with their families four months extra each year is worth more than the additional \$50,000 they will make if the big government taxation crew gets its way?

If the surgeon would have taken home \$50K after taxes at 39.6%, that's \$82,781 before taxes, which would have been \$53,808 if it had been taxed at the original 35%. So your suggestion is that a surgeon would would work an extra 4 months (not going to question your numbers here, although I have no clue how you reconcile them with your other numbers) that he might otherwise not have worked if we offer him \$3,808?

I can't imagine why nobody takes your analysis seriously.

By Troublesome Frog (not verified) on 06 Mar 2009 #permalink

WW opined, "Take for example, Ken Davis, of Ken Davis BBQ sauce fame, who was struggling for many years trying to sell his BBQ sauce in Minnesota. He would sell it door to door, at super markets, and even stopping in at bars, selling it out of the back of his station wagon."

I assume this is the same Ken Davis:

http://www.kendavis-bbq.com/about.html

It seems to me that your claim that Ken Davis couldn't grow his company until he got a tax cut isn't substantiated by any evidence I can find.

You are going to have to be more explicit about how any tax break Ken Davis got allowed him to grow his business. How much taxes did he pay? How much of a tax break did he get under Reagan? He incorporated his business in 1973, when did he feel it was successful?

He apparently started manufacturing in bulk in 1980 through an agreement with Apex distributing Company.

Nope, nothing which suggests from the information available to the public that it was the Reagan tax cuts which provided him the money, especially as the cuts happened in 1981, and he had already started making his sauce in bulk quantities.

Did anyone here say that it's a bad thing for people to become millionaires? No.

See [#35] and [#40]. Seriously. Go check. They're right here, on your blog, before you wrote what you just wrote.

You responded with a strawman about how people are going to stop working if their taxes go up. Of course, you can't provide *any* evidence for that - because historically, there's never been a time in the US when people have stopped working in order to avoid taxes./blockquote>

If you're gonna put words in my mouth, you might as well stretch the truth. I didn't say stop working, as in retire, I said they would slow down.

If you want evidence, conduct the following experiment: go try to hire a professional of some sort, say a lawyer. When he tells you his fee is \$120/hour, tell him you'll give him \$40/hour, by check or credit card, paid to the name of his business. See if he wants the extra money you're offering.

On the other hand, go find an auto-mechanic. If the shop he works at charges \$90/hour, see if the auto-mechanic would be interested in moonlighting for \$90/hour cash (i.e., tax free) to give your car a tune up this weekend. See if he's willing to work more.

If I told you my sh*t was brown, you'd demand a scientific double blind study showing that the 95% confidence level shows that between 99.2% and 99.7% of the population would identify my crap as being brown.

The only ones spewing BS are the ones who poo-poo the idea of incentives and disincentives.

Regards,

WW

By William Wallace (not verified) on 06 Mar 2009 #permalink

Sorry about the blockquotes.

Did anyone here say that it's a bad thing for people to become millionaires?

No.

See [#35] and [#40]. Seriously. Go check. They're right here, on your blog, before you wrote

what you just wrote.

You responded with a strawman about how people are going to stop working if their taxes

go up. Of course, you can't provide *any* evidence for that - because historically, there's never

been a time in the US when people have stopped working in order to avoid taxes.

If you're gonna put words in my mouth, you might as well stretch the truth. I didn't say stop

working, as in retire, I said they would slow down.

If you want evidence, conduct the following experiment: go try to hire a professional of some

sort, say a lawyer. When he tells you his fee is \$120/hour, tell him you'll give him \$40/hour, by

check or credit card, paid to the name of his business. See if he wants the extra money you're

offering.

On the other hand, go find an auto-mechanic. If the shop he works at charges \$90/hour, see if the

auto-mechanic would be interested in moonlighting for \$90/hour cash (i.e., tax free) to give your

car a tune up this weekend. See if he's willing to work more.

If I told you my sh*t was brown, you'd demand a scientific double blind study showing with a 95%

confidence level that between 99.2% and 99.7% of the population would identify my crap as being

brown.

The only ones spewing BS are the ones who poo-poo the idea of incentives and disincentives.

Regards,

WW

By William Wallace (not verified) on 06 Mar 2009 #permalink

If you want evidence, conduct the following experiment: go try to hire a professional of some sort, say a lawyer. When he tells you his fee is \$120/hour, tell him you'll give him \$40/hour, by check or credit card, paid to the name of his business. See if he wants the extra money you're offering.

What about if you give him \$118 an hour? Total meltdown, or negligible change in output?

By Troublesome Frog (not verified) on 06 Mar 2009 #permalink

Interesting. At this IP address the Comment Box disappears as fast as it did yesterday. Since I wasn't able to move fast enough to comment without 'signing in', and since my complaint to TypeKey resulted in them sending me a password that I must have created sometime somewhere, I 'signed in' in order to write this. Perhaps the difference in how fast the Comment boxes disappeared is that at the other IP address I am on dial-up. I never thought that being on dial-up would facilitate communication!

Mark, I can see where WW has assumed that because I feel that a reduction in the number of millionaires throughout the 50's - 70's, which indicates a decrease in lower-class households as well an increase in middle-class households, could be taken as a statement that it's a bad thing for people to become millionaires.

WW, as usual, is not seeing the forest for the trees. I do not think it is a bad thing for people to strive to become millionaires. However, the number of millionaires is an indicator of cash available to the economy. A reduction in the number of people accumulating that cash can only help the economy grow. Even WW appears to acknowledge that cash flow is what helps the economy by his statement that the rich hire people. (Without being able to see that the middle-class hire far more people than the rich.)

What WW doesn't seem to understand is that excessive accumulation of cash and wealth slows down the economy and causes inflation. Basic macroeconomics. So a reduction in the accumulation, in aggregate, can be viewed a benefit.

However, I did not intent to suggest that people shouldn't be allowed strive to become millionaires. That is the fallacy of taking a statistical, aggregate, view of economic principles and applying them to an individual.

Finally, no one here is poo-pooing the idea of incentives and disincentives. In fact, I clearly suggested that a disincentive of a high top marginal tax rate would be a disincentive for taking a salary at that marginal tax level.

I also showed how historically it benefited society.

No one refused to work because of the higher marginal tax rate, what happened is that salaries were set to just below the highest marginal tax rate.

WW, you contend that if a brain surgeon was taxed at a higher marginal tax rate, they would only work for 2/3rd of a year. Bullshit. Let's say, using your example, that there was a 90% tax bracket for earnings above \$500,000/yr. Your brain surgeon wouldn't work for eight months and then stop working, he would negotiate for \$500,000/yr but would ask for another \$100,000 in indirect compensation. Things like a company car, travel allowances, free trips to conferences, etc. And he would get them. But all of those perks are putting money back into society, i.e. it is not accumulating.

This is what happened when there was a 90% top marginal tax bracket. The thing is, as company earnings continued to increase executives started to run out of the number of tax-free perks they could get. But the profits were still coming in. So the companies provided health care packages, pension plans, increased dividends to stockholders, built new offices, gave away lots of money to charities, etc. All of which are better for society in a macroeconomic sense than increasing executive compensation.

Cash is king, both for corporate finances and macroeconomic principles. Cash flow is probably the most important indicator of the health of an economy. The reason for the current major meltdown is that cash has stopped flowing. There are good reasons why the cash has stopped flowing, based more in psychology than economics (although the more I study economics the more it seems like applied psychology).

However, no one here is saying you shouldn't be allowed to hoard as much cash as you wish. Go right ahead. Just do it ethically, legally, and pay your taxes on it.

To #46 and #47

What point exactly are the examples given supposed to illustrate? A better experiment, I would think, would be which of two professionals with a less than completely filled workload would be more likely to take on new business, the one with costs rising (small increase to the marginal tax rate) or the one with costs falling (small drop in the marginal tax rate). In the vast majority of cases, the rational thing to do in the face of rising costs is to do more work. The conservative argument that people will generally respond to a lowering of their costs by working more is not born our by reason or experience.

WW said: If you want evidence, conduct the following experiment...

We see here that WW went to the Michael Behe School of scientific protocol, wherein it is the critics of a theory, and not its promoters, who must do the experiments, while the theory's promotors tend to more "fruitful" endeavors.

Mind experiments are not evidence WW. Yeah, yeah, I know the pat response. I've got good friends who've hit me with versions of this every time I challenge them on some wild-assed assertion they make:

WW: "If I told you my sh*t was brown, you'd demand a scientific double blind study... [blah blah]"

If I had never seen brown shit, and knew a lot of really smart people who had studied shit for a long time and had degrees in scatology that didn't even think brown shit was possible, yeah, I'd want more evidence than your say so. How else are we to know when someone is, ahem, full of shit?

Tax banding was originally created to approximate a polynomial regression in a way that didn't require the use of a computer. This made absolute sense at the time, since there were no such things as computers; and when the first ones came on the scene, they didn't have the required processing power.

Tax bands were only ever a compromise. The calculations were kept within the bounds of what a person could reasonably do in their head (and remember also, money hasn't always been divided up into neat hundreths the way it is today: a pound used to consist of 20 shillings, each of 12 pence. Decimalisation made the maths easier, but they didn't introduce more tax bands) while still making provision that the more you earn, the more you pay.

Nowadays, fast, reliable computers are ubiquitous. So why can't we simply switch over to using a true polynomial regression to calculate income tax? Rich people would still pay more tax than poor people; they just wouldn't have any way to avoid paying what they were supposed to by moving their money around a bit (e.g., selling stuff at a loss to a less-profitable company you also own, thus decreasing "your own" tax liability without unduly raising "theirs").

For the sake of minimising disruption due to the change, I think the transition probably should be made over a period of several years. Say, in year one you would pay 80% of the amount worked out using the old, banded system plus 20% of the amount worked out the new, polynomial system; year two, 60% banded + 40% polynomial, and so on.

AJS wrote, "Rich people would still pay more tax than poor people; they just wouldn't have any way to avoid paying what they were supposed to by moving their money around a bit (e.g., selling stuff at a loss to a less-profitable company you also own, thus decreasing "your own" tax liability without unduly raising "theirs")."

This sort of behavior is not related to the marginal brackets. It's related to adjusting income to arrive at a lower tax bracket. Taking gross income and adjusting it to account for losses is not something I'm particularly against. The difference between gross income and the income available for use by the taxpayer (private or business) can be significant, and if the income tax is strictly based on gross income situations may arise where a person owes more tax than they have assets. So allowing some deductions to be made for some major expenditures or losses (even if the losses were the individuals own fault) really does help out both the taxed and taxer. It is not the intent to tax people into bankruptcy.

That some people do abuse this system and claim excessive deductions, relying on the inefficiency of the IRS to not notice them, is an unfortunate side effect of this type of system.

One thing your proposal would do is eliminate the slight discrepancy in the tax tables near the cross-over points of the brackets. There are times when a person is near the cross-over points of the tax brackets where earning a few extra dollars means paying a little more in tax, at least according to the tables. I've got the tables right here.

Let's say your adjusted gross income was \$55,701. The tables say you need to pay \$10,275 in taxes. However, if your adjusted gross income was \$55,699, you would only pay \$10,263 in taxes. Meaning that by making only \$2 more, you pay \$12 more in taxes.

However, these effects are only seen at the junction points and are fairly minor overall.

I've been getting confused emails regarding my participation here. To set the record straight, it was MarkCC in #7 who brought up the "Laffer curve" strawman. And it was MarkCC in [#42] who brought up "sh*t" and "bullsh*t".

In closing, for any open minded liberals out there, I think you need to re-assess the foundation of your political philosophies. I suggest, as a starting point, reading John Locke's "The Second Treatise of Civil Government". It is available on-line for free, and also at most university libraries, and many public libraries.

Regarding [#51], I'm not buying it, because you have already, in your own life, seen how offering a reduced marginal pay results in individuals wanting to work less. I assume, for example, you're not moonlighting at Burger King for the extra cash you could get. In other words, you demand ridiculous standards of evidence for phenomena that you already experience in your own life--not because it is difficult to believe, but because it doesn't support your political agenda. Hence, my lighthearted example, playing on MarkCC's sh*t comment, regarding the color of sh*t.

WW

By William Wallace (not verified) on 08 Mar 2009 #permalink

WW opined, "In other words, you demand ridiculous standards of evidence for phenomena that you already experience in your own life--not because it is difficult to believe, but because it doesn't support your political agenda."

You'll have to be clearer for those of us who are slow on the uptake.

So far as I can tell, your claim is that a minor marginal decrease of income for people making 8+ times the average income level would be enough to encourage them to spend less time working. Thus destroying our economy.

If you want to scale down the example to be more at our level, you should use equivelent analogies. You are not claiming that your hypothetical brain surgeon should be taking another job, you are claiming that because his effective income level drops he will work less. We have challenged that claim, mainly on the basis of plenty of historical information that for most people the opposite behavior is observed. People would like to work more.

You are trying to support the argument that people will work less when taxes are raised with evidence that people don't choose to work more when taxes are static. They are not equivalent, your evidence doesn't support your conclusions.

Further, what political agenda are you referring to? I admit I'm a liberal, I'm even a politician, but I'm just as much against overtaxing people as any conservative. We are considering lowering the millages in our township because we believe we will be able to provide the same level of service with a reduced millage. The services we provide are those the population wants.

Services must be paid for, and the only means we have of generating the income to pay for services is through taxation. When the demand for services increases beyond the level of income, taxes must be raised. Because unregulated capitalism operates on a boom-and-bust cycle, government must occasionally borrow money to ensure services continue when the tax income is reduced because of an economic slowdown. Further, government spending can alleviate an economic slowdown to a large extent through deficit spending. Deficit spending induces a hysterisis into the economic cycle, essentially smoothing out the boom-and-bust cycle.

So, government spending is necessary to provide the services demanded by the citizens and can also be used to benefit society in general. But this must be paid for. While I have read good arguments that the rich benefit more from an open and stable society than the poor do, I'm not certain that I agree that the benefits are that much greater for the rich.

It is clear to me, however, that any hardships induced by additional taxation on the wealthy are going to be less of a hardship than on the poor.

It is also clear to me, as I argue above, that economies grow through cash flow; which is reduced as wealth is concentrated in a society.

Add to that the very evident truth that the wealthy people have more opportunities that poor people. That is, they can choose to do things which are denied to other people simply because of their level of wealth, like fly to Paris for a weekend. Which is, of course, why people want to be wealthy in the first place.

All this makes it clear to me that if we must pay down our deficit, and continue to provide the services demanded of our government, it makes sense to me that a somewhat larger percentage of the burden should be placed on those people who can bear it best.

The arguments against taxing the wealthy more are always an appeal to 'fairness'. That's like saying that both the 98lb weakling and the 240lb Charles Atlas should carry a load which is 20% of their body weight and expect them to go the same distance. Who can carry the load further, the weakling carrying 20lbs, or Charles Atlas carring 50lbs? If you want them to carry their loads the same distance, Charles needs to take some of the load from Milquetoast. Even if if means that Milquetoast only carries 5lbs and Chuck carries 65lbs. A 75% reduction in one, means only a 30% increase in the other.

I agree with your general argument that higher marginal rates do not lead to a greater expenditure of effort leading to a reduction in net income, but the Obama proposals, as I understand them, also include a stepwise reduction in itemized deductions as gross income increases. I've no idea of the actual numbers, but this program certainly could, in theory, cause one to net less from a gross of \$251,000 than from \$249,000.

Flex @ #55,

Brilliantly put.

What nobody ever seems to want to admit is that there is a fixed sum of money in the economy; so the poor will never get any richer unless the rich get poorer.

But you've just demonstrated how, in order for the poor to get a lot richer, the rich only need to get a little poorer.

Anyway, if the rich want to cut off their dicks to annoy their bollocks, I say let them. The work they aren't doing for fear of paying too much tax will still need doing, and somebody who isn't afraid of a bit of hard graft can always earn out of it.

AJS writes: What nobody ever seems to want to admit is that there is a fixed sum of money in the economy....

Nobody ever admits it because it isn't correct, either literally (central banks change the money supply all the time) or in the sense of total value (measured by, for example, the combined gross domestic products of the world's nations). Or did you think that, e.g., today's information technology industry is limited to producing the amount of wealth/value that manual calculators and typewriters were responsible for decades ago?

1) "I've no idea of the actual numbers, but this program certainly could, in theory, cause one to net less from a gross of \$251,000 than from \$249,000." That is rubbish. The progressive tax rate, not all the weird effects from the AMT and FICA, are simply defined. All income up to a certain level is taxed at one rate, all income above that level, but below the next is taxed at another rate, and so on. The curve is monotonic, since you are always adding the portion from the new bracket. (At least as long as the rate is under 100%).

2) In the 1950s and 1960s, the peak marginal rates were 90% and we had GDP growth that we can only dream about today, not to mention rising incomes and standards of living. That's the history. Any theory has to explain that. The rates actually encourage investment if you think about corporate structure. The management of a company only has to pay the owners of the company enough money as dividends to support the stock price. They can take anything beyond that for themselves. High marginal tax rates made it worth less to simply raid the corporate treasury as is common practice now. Instead, the money remained in the corporation where it could go towards buying new equipment and hiring better, smarter workers.

3) I'm not arguing that the tax code is very weird. When Reagan raised taxes on every W-2 income, he gave me a real bump in my earning power. I only had to pay FICA and the lie on the first \$50K. I remember the big boost in my take home pay when I broke the line. I got an extra 5% in November and December. Since this is a math blog, I'll throw that down as a challenge. What was my salary that year? (Goodness, how old am I? I almost wrote \$50G, for fifty grand. For extra points, how many dollars in a grand?)

Well, quite a lot of discussion. I'm a tax accountant and, as a professional, I have to say I am unsurprised at the complete lack of understanding people have of the marginal tax rates and the expiration of the temporary Bush cuts.

Rather than try to explain a serious, complex work on human behavior vis marginal tax rates, I'll just give you the bottom line: you do not see any significant change in economic acts, or engagements in tax avoidance, including earnings avoidance, below a Federal marginal tax rate of 40%. At Federal 40% people do start doing some strange things, but below Federal 40% only the die-hard, self-important cheats engage in meaningful avoidance (or even evasion) strategies. This is why, during TRA '86, the tax rates were lowered to 36% then, eventually, raised to 39.6% on the marginal "last dollar" earned for high income taxpayers.

I've learned a couple of things. I couldn't figure out why people had a great fear of making over \$250,000 a year with Obama's promised tax increase. The article tells me why some people think they will net less money if they make more. I don't think Joe the Plumber was in much danger anyway. And a good thing about this economy is that apparently fewer people now have this fear.

And from the comments, I learned that the Laffer Curve tells us that with a cut in marginal tax rates, there is increased demand for barbecue sauce. I wouldn't have even suspected that.

By Steve Lee (not verified) on 02 May 2009 #permalink

"LOL! At least Mark's made up tax rates resembled real tax rates."

Oh the irony. 70% *is* a real tax rate, just not in the states, yet. And yes, I was born and raised in Scandinavia where such rates not only exist, they kick in a *lot* sooner than \$250k. Above some threshold people really do stop working, which really does create a shortage of highly-paid professionals, most notably doctors, which really does increase demand and enables these professionals to charge more and more for their services. And it really does reach the point where doctors work only a few months a year and spend the rest of the year abroad (where the cost of living isn't inflated by high taxes). And all the while they're paid with tax money, so consumer choice doesn't enter into it. Instead all the decisions on what constitutes reasonable fees and so on are made haphazardly by politicians via rhetorical debates ("my opponent wants you to die from cancer, whereas I'm willing to spend what it takes to make you well"), and lobbyism.

The social and cultural impact is noteworthy, too, and contrary to the propaganda, high taxes do little to bridge the gap between the rich and the poor.

By Returning Tarzan (not verified) on 06 Jul 2009 #permalink

"I think most people would agree to the following:
1. If the government set the income tax rate to 0% it would get no income tax revenue because no one would have to pay taxes.
2. If the government set the income tax rate to 100% it would get no income tax revenue because no one would work.

If you accept the above two points, than it follows from Rolle's Theorem that there must be some point in the range (0%, 100%) that results in maximum revenue. If your tax rate is beyond this point then reducing it to that point would necessarily increase total revenue.

In that sense, the Laffer Curve is logical."

Actually, for this to be mathematically correct one must assume that the dependance of revenue on tax rate is continuous and differentiable. Rolle's theorem then states there is a point where the slope is zero. Since revenue is a positive (or zero) number, you will be able to find a maximum.

The question is whether the dependence of revenue on taxes is continuous. According to the news story, due to the misunderstanding of how taxes work, people tend to make quite drastic changes in their income (and thus taxes paid) prompted by minor changes in the tax rate. This suggests to me that the Laffer Curve may not be continuous or differentiable. It may not have a maximum (it will have a supremum, since I doubt that revenue can grow unbounded, whatever the tax rate...)

Just my bit of mathematical nitpicking.