Tax the Rich, Kill the Economy? Here's Proof It Doesn't Work That Way

Tax the rich

Republican presidential candidate Mitt Romney wants to extend the Bush tax cuts, and cut taxes even further in order to boost economic growth. In contrast, President Barack Obama argues that in order for the government to to pay its bills, we must allow the Bush tax cuts to expire (at least on the wealthy) and add surtaxes on high-income taxpayers in order.

But would cutting taxes on "job creators," as Gov. Romney proposes, rather than raising taxes on "the rich," as the President proposes, actually boost economic growth? No -- at least not according to the Congressional Research Service.

A Storm in the Making...?

Last week, in a headline that seemed about to spark a firestorm on the Internet (until Governor Mitt Romney's "47%" video preempted the pundits' attention), the CRS took up the question of whether "reduced [tax rates on the wealthy] would increase economic growth, increase saving and investment, and boost productivity."

Their conclusion: It wouldn't.

To the contrary, after 20 pages of charts, graphs, and economic navel-gazing, the CRS came to a startling (to some) conclusion: A review of 65 years of tax and economic data running from 1945 (when top capital gains and top marginal income tax rates topped 90%) through 2010 (by which time the top income tax bracket had declined to 35%, and the capital gains rate had fallen to 15%) shows no "conclusive evidence ... to substantiate a clear relationship between the 65-year steady reduction in the top tax rates and economic growth." (Here -- see for yourself).

capital Gains tax

Rather, the "data suggests the reduction in the top tax rates have had little association with saving, investment, or productivity growth." These reductions did, however, result in "increasing concentration of income at the top of the income distribution. The share of income accruing to the top 0.1% of U.S. families increased from 4.2% in 1945 to 12.3% by 2007 before falling to 9.2% due to the 2007-2009 recession."

To summarize: Lowering taxes on the wealthy makes the rich richer, and doesn't do anything to boost economic growth.

... Or Just a Tempest in a Teapot?

The reaction from the political right wing was just as you'd expect, with the conservative think tank The Heritage Foundation firing off a quick rebuttal: "The Congressional Research Service ... set out to make a convincing case that lower income tax rates do not strengthen the economy. It failed, but in so doing, it called into question the quality of CRS analysis and the institution's credibility as non-partisan."

Heritage proceeded to work itself up into a fine lather, declaring that no matter what the data show, it is "impossible ... to argue that lower [tax] rates do not encourage stronger economic growth." The attempt to do so is "simplistic," "flimsy," and "misleading."

Impossible why? Apparently, just because the Heritage Foundation says so: "Of course, if you tax income, investment, and savings less you'll get more of them and the stronger growth that comes with the increase in these activities."

(Oh, well. If it's "of course," then I guess there's no point in looking at evidence ....)

Can't We All Just Get Along?

Now to be fair, Heritage's argument sounds sensible -- even in the absence of evidence to back it up. Taxing anything makes it more expensive, and as we all know from Economics 101, when the price of something goes up, demand for it goes down. (It's right there in the line graph.) Logically speaking, therefore, the Heritage Foundation's argument should be right, and the CRS's data should have shown this to be the case.

Except it didn't.

Instead, the CRS research showed that lowering the rate of the top income tax bracket was "not associated with private saving" and "not necessarily associated with productivity growth." As far as growing the economy goes, the "fitted values seem to suggest that higher tax rates are associated with slightly higher real per capita GDP growth rates."

So... so much for that theory. Apparently, now we're stuck with only two options. Option 1: Dismiss the facts as "impossible." Option 2: Follow a new theory that better fits the facts.

Pop Quiz: Who Are the 47% -- And How Much Do They REALLY Pay?
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Tax the Rich, Kill the Economy? Here's Proof It Doesn't Work That Way

A. 46%
B. 32%
C. 18%
D. 10%

Most tax filers pay payroll taxes like Social Security and Medicare. In fact, only 18.1% don't send anything to the Federal government. Of these, almost 57% are elderly, and don't bring home a regular paycheck.

A. 1.2 million
B. 162,000
C. 53,000
D. 2,000

More than 162,000 people who are among the top 10% of all earners -- basically, those who make over $163,173 -- didn't pay any federal income tax in 2011. Among the top 0.1% of filers -- the richest households in the country -- 3,000 (2.3% of them) didn't pay income tax in 2011.

A. Red states
B. Blue states
C. They're about equally distributed

Of the 20 states with the highest percentage of non-income tax-paying filers, twelve are firmly in the red camp. On the opposite end of the spectrum, just three of the 20 lowest-percentage states skew red.

A. 41%
B. 37%
C. 23%
D. 12%

In terms of total effective tax rate -- the total percentage of income that a taxpayer sends to the federal government, from excise taxes, corporate taxes, payroll taxes, and other levies -- the poorest fifth of Americans pays an average of 17.4%. The top 1% pays 29%, so they pay 11.6% more than the poorest 20%.

A. 67%
B. 51%
C. 34%
D. 19%

The top 20% of taxpayers pay 63.1% of all taxes and take home 59.6% of all income. In fact, all income groups pay a percentage of the total federal tax revenue that is almost equal to the percentage of America's income that they take home.

A. The bottom 20% of earners 

B. The top 1% of earners

While state taxes vary depending on where you live, every state hits the working class harder than the top 1%. The best state is Vermont, where the richest 1% pay 7.5% of their income and the poorest 20% pay 8.2% -- or 1.1 times as much. The worst state is Washington, where the richest pay a measly 2.6% of their income and the poorest pay a staggering 17.3% -- or 6.7 times as much.

A. 20%
B. 13%
C. 7%
D. 1%

In terms of total effective tax rate -- the actual percentage of income paid into taxes, accounting for all credits, exemptions, deductions, and so forth -- the richest 1% of the country pays 29% of its income. The middle 20% pays 28.3%, or 0.7% less. For that matter, it's worth noting that the poorest 20%, the group least likely to pay federal income tax, still sends 17.4% of its wages to the taxman.


Motley Fool contributor Rich Smith gets a bit nervous when politicians start talking about raising taxes on the rich. His only request: "Please don't forget the definite article."
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