Taxing the 1% IV: Incentives
As noted in previous essays on this topic, the highest income folks in the United States now pay about 1/3 of their income in taxes. The left has proposed increasing the tax rate to 40% or even 45% while the right has countered with proposals to either not raise taxes or cut them even more. This, the final essay in this series, considers the stock argument that a tax increase will be a destroyer of incentives.
The gist of the argument is that if the taxes for the top income brackets is increased to 40% or higher, the rich will become demotivated and this will have negative consequences. Since these negative consequences should be avoided, the conclusion is that taxes should not be increased—thus keeping the incentives in place.
In terms of assessing this argument, there are two major points of concern. One is whether or not a tax increase would destroy the incentives of the top economic class. The other deals with the negative consequences, their nature, their likelihood of occurring and the extent and scope of the harm. I will begin with the alleged consequences.
The alleged consequences are many and varied. One is based on the claim that the top economic class contains the innovators and if they are demotivated, then there will be less innovation. This could range from there being no new social media platforms to there being no new pharmaceuticals. While this is a point of concern, this assumes that innovation arrives primarily out of the top economic class—a matter that can tested empirically. While some top earners are innovators, much of the innovation seems to come from those in the lower economic classes—such as the folks in the labs doing the actual research and engineering. The idea that the rich are the innovators certainly matches the fiction of Ayn Rand, but seems to miss the way research and development actually occurs.
Another is based on the claim that the top class serve as the investors that provide the capital that enables the economy to function. Since the top class controls the capital, this is quite a reasonable concern. If Americans with the largest shares of the money decided to reduce or stop investing, then the economy would need to rely on foreign capital or what could be provided by the lower classes. Since the lower classes have far less money (by definition), they would not be able to provide the needed financial support. There are, of course, foreign investors who would happily take the place of the wealthy Americans, so the economy would probably still roll along. Especially since American investors might find the idea of losing out to foreign investors sufficient motivation to overcome the demotivation of a tax increase.
There is also the claim that the top income class contains the people who do the important things, like brain surgery and creating the new financial instruments that will take down the world economy next time around. While this does have some appeal, it seems that much of the important stuff is done by people who are not in the top classes. Again, the idea that the economic elite are doing the important stuff while the rest of the people are not (or are takers rather than makers) is yet another part of the fictional universe of Ayn Rand.
Fairness does, however, require that these matters be properly investigated. If it can be shown that the top class is as critical as its defenders claim, then my assertions can be refuted. Of course, it is well worth considering that much of the alleged importance of the top class arises from the fact that it has a disproportionate share of the wealth and that it would be far less important if the distribution were not so grotesquely imbalanced. As such, a tax increase might have the impact of decreasing the alleged importance of the top economic class. I will now turn to the matter of whether or not a tax increase would demotivate the top economic class.
One easy and obvious response to the claim that a relatively small tax increase would demotivate the top economic class is that the vast majority of the rest of us work jobs, innovate, invest and do important things for vastly less than those at the top. Even if the rich paid slightly more taxes, their incomes would still vastly exceed the rest of us. And if we can find the motivation to keep going despite the relative pittances we are paid, then the rich can also do so. When I worked a minimum wage job, I was motivated to go to work. When I was an adjunct making $16,000 a year, I was still motivated to go to work.
It could be replied that the lower classes are motivated because they need the income to survive. We need to work to buy food, medicine, shelter and so on. Those who are so well off that they do not need to work to survive, it could be claimed, also have the luxury of being demotivated by a slight decline in their income. Whereas someone who must earn her daily bread at a crushing minimum wage (or less) job has to get up and go to work, the top economic folks can allow themselves to be broken by the slight tax increase and decide to stop investing, stop innovating, and stop doing important stuff.
One reply is that it seems unlikely that the top folks are so weak as to be broken by a slight tax increase. Naturally, a crushing increase would be a different story—but there are no serious proposals to inflict crushing tax burdens on the rich. After all, crushing burdens are for the poor. Another reply is that if the current rich become demotivated, there are plenty of people who will be happy to take their place—even if it means paying slightly higher taxes on a vastly increased income. So, we would just get some new rich folks to replace the demotivated slackers—capitalism at its finest.