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Tess Vigeland: When members of Congress return from Thanksgiving recess, they’ll have plenty of leftovers to gnaw on in terms of legislation with looming deadlines. The estate tax, unemployment benefits and, of course, the end-of-year expiration of Bush-era tax cuts. Much has been made of extending cuts for anyone under the $250,000 income threshold. But recently there’s been some talk of raising that cap to $1 million.
Commentator David Frum doesn’t think that’s a solution either.
David Frum: America is not exactly in love with the super-rich these days. Super-rich no longer conjures up Steve Jobs bringing us the iPhone or Google putting all the world’s knowledge at our fingertips.
The phrase instead conjures up investment bankers who wrecked the American housing market — and then dumped the bill on the U.S. Treasury. So you can understand why the idea of a new higher income tax rate for people earning more than $1 million a year has gained political traction.
But it’s still a terrible idea. Higher tax rates exact real economic costs: Maybe two dollars in dead weight loss to the economy for every extra one dollar collected. That’s according to Martin Feldstein of Harvard and the National Bureau of Economic Research.
One reason that higher rates do so much harm: Very rich people have a lot of economic options. If income tax rates rise too high, they will invest time, energy and money to redesignate their income. If, for example, corporate tax rates are lower than personal, they’ll hold income inside corporations. Or their accountants will invent ways to transform income into capital gains or to generate tax losses.
This tax avoidance by the rich is cumbersome and ineffective for the rich themselves. So if the tax rates are set at reasonable rates, tax compliance becomes the better deal. This was the thinking behind the tax reforms of the 1980s: At a maximum rate of 27 percent, it simply was not worthwhile to pay the lawyers to invent tax shelters.
There’s a lesson here for today. The job of the tax system is to raise revenues for the state in ways that do minimum harm to the economy. The job is not to punish unpopular groups of people, especially when the punishment does much more harm to the overall society than to the intended targets.
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