THE PROGRESSIVE INCOME TAX
What would you think if a politician were to stand before you and tell you that he favors a tax scheme that would raise all the money the government could ever hope for from wealthy taxpayers without any of them being required to give up any of their purchasing power? (I.e., affluent households would find that their smaller disposable incomes are buying them just as much in the marketplace as their pre-tax incomes would have bought them if they not been required to pay any tax at all.)
That is the true beauty of the Progressive Income Tax. Rich people end up paying most of the taxes the government requires, but none of them really suffers in any sense that really matters, not in terms of purchasing power, not in terms of obtainable material possessions, not in terms of lifestyle. How could such a thing be possible? Answer: we have a market economy.
In a market economy, it is an absolute certainty that if all the incomes of rich people are reduced by the same percentage, the prices of all the luxury goods/services/experiences that rich people typically buy will drop to a level that they can afford. None of the mansions or Van Gogh's or beach front properties would disappear; they'd be just as available as before, only at lower prices.
To better understand this fundamental economic reality, it helps to consider the purchasing power effect of two completely different dollar-enrichment scenarios: one, in which only a single, or only relatively few, households experience a dramatic increase in $$ income, and one in which all households experience a dramatic increase in their $$ incomes.
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LOTTERY WINNERS VS. “EVERYONE A MILLIONAIRE!"
When individual lottery winners collect their millions, they enjoy a dramatic increase in their purchasing power. Suddenly, they are able to make a claim on the scarcest goods/services/experiences that the economy makes available. But what if our politicians in Washington were to decide one day to simply hand out fifty-million dollars to every household in America? Wouldn't that mean that we'd all be able to share the same great experience of luxury living? Well...no.
Economists understand that such a plan would simply cause an explosive round of inflation. Over a fairly short period of time, the price of everything would skyrocket dramatically. After the hyperinflation had finally run its course, there would still be the same rough percentages of rich and poor and middle class citizens in the country as there were before the million-dollar gift was distributed.
Why is this true? It's because the quantity of goods & services that would be available in the country the day after the million dollar giveaway was distributed would be essentially the same as the quantity that had been available the day before. Doubling every taxpayer's nominal income with a gift of 'free money' does not magically double the number of limos, mansions, and priceless one-of-a-kind art objects that are available.
The end result? After the hyperinflation has run its course, the same quantity of goods & services would be consumed as before, just purchased at dramatically higher prices. In real terms, there would be no overall improvement in the standard of living of the citizenry because it is not money, itself, which gives us our standard of living, but only the real goods & services that we are able to produce and bring to market.
Between 1960 and 2001, the Republicans succeeded in reducing the top income tax rate that rich people pay from 90% to 35%. When they did this, it had the same effect on the real standard of living of rich people that we saw in the "everyone a millionaire!" scenario described above. That is to say, they did not benefit at all, in material terms, even though many other people did suffer, due to the unemployment that it caused. (I'll explain why later.)
None of the extra disposable dollars the Republicans pumped into 'their side' of the economy caused any more mansions, yachts, or Van Gogh's to be produced than we would have seen anyway if the tax cuts had never occurred. That's because the upper class would still have had the highest disposable incomes in the land and suppliers of the luxury markets always---in any conceivable market conditions---do everything in their power to bring more scarce luxuries to market, because "that's where the big bucks are."
When the rich got their taxes cut by Republican politicians, most of them believed they were better off because they added up the extra dollars they were taking in and imagined what those extra $$ would buy them if only they had received the money gift, and not all rich people in general. (The only time a big boost in disposable income will actually increase your purchasing power is when it doesn't also happen to everyone else.)
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THE MARKETPLACE
In a market economy, suppliers can be counted on to charge the highest prices that their markets will bear. That is to say, they will charge as high a price as they can, so long as they are able to sell everything they have [or can get]. If a shortage develops in some market, sellers will raise their prices because they know that some people will be willing to pay a higher price for what little there is. Buyers will pay those higher prices because 1) they have the money to do so, and 2) they don't want to do without.
Sellers also raise their prices if they notice that an increase in disposable incomes has occurred, like whenever the Republicans reduce the tax obligations of rich people. They want to get as much money as their customers are willing to pay, period. The only way they are able to find out what the optimal price might be is by raising their prices until they are no longer able to sell off all of their inventory.
It helps to understand why economists say that markets auction off the scarcest goods & services to the highest bidders. As noted earlier, suppliers always set their prices as high as they can. Consumers who are willing and able to pay those prices get to be successful bidders. Those who cannot afford to pay the seller's asking price do not even bother to 'submit their own bids' unless/until the official selling price is lowered to a level that they can afford. In other words, in this kind of 'auction', the only bids that are ever offered are those that are certain to be accepted.
If a supplier sets her prices higher than she should, she won't be able to sell all of her product. She will then have to lower her prices to a level that more consumers find affordable. If, on the other hand, she doesn't charge the highest price she can get from the market, she'll find that she has too many customers clamoring for the limited amount of things she has to sell. She will then want to raise her prices until she finds out which higher price imaginable is still low enough for her to sell all of her product.
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HOW MUCH DO YOU EARN COMPARED TO EVERYONE ELSE?
Due to the limitations imposed on us by Nature, our economy is not able to produce enough of the "best quality" goods & services so that everyone can experience them. In a market economy, if you want to be one of those who is able to experience the rarest of economic privileges, then you must obtain a level of disposable income/wealth that is high enough for you to outbid other potential consumers for them.
What is important is not the dollar wealth you are able to accumulate; it's the dollar wealth you are able to accumulate compared to everyone else. The purchasing power of your income is determined solely by its relative position within the hierarchy of all accumulations of disposable income/wealth. Because we have a market economy, an individual can improve her claim on the scarcest goods & services only if she can improve her comparative bidding position within the hierarchy of national income/wealth distribution.
Whenever an individual household is able to increase its disposable income, its purchasing power will either increase, decrease, or not change at all depending on what has happened to the disposable incomes of all other households. If your disposable income remains the same next year but everyone else's income declines, you will actually see the purchasing power of your stagnant income increase. Suppliers would be forced to drop their prices and you would discover that you have acquired a bidding advantage over others. Even if your income were to drop next year, you would still be better off if everyone else's income dropped even more.
Understanding how markets respond to widespread changes in disposable income makes it easier to see why THE PROGRESSIVE INCOME TAX does not impose any real sacrifice on taxpayers in terms of lost purchasing power. If there are no loopholes or special allowances written into the tax code, those who earn more pre-tax income than you end up with more disposable income than you after everyone pays their taxes. Those who earn less pre-tax income than you end up with less disposable income than you. The same reality holds true for every other taxpayer. Let's look at a more detailed example of how this would work out if our top tax bracket was set at 99%.
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HOW MARGINAL TAX RATES WORK
Imagine that one year Bill Gates is the top income earner with a gross income of one billion dollars. If all of that income were taxed at a 99% rate, he would be forced to somehow get by on 1% of a billion dollars, or $10,000,000. Let's say that Paul Allen earns $800,000,000 in gross income that year and all of that income is taxed at a 98% rate. This would leave him with $16,000,000 of disposable income. Such a result would be extremely unfair, wouldn't it? Bill would end up with a smaller disposable income ($10,000,000) than Paul ($16, 000,000) after taxes even though he earned more than Paul in gross income.
This kind of result does not occur, however, when you employ marginal tax rates, like we do now with our current tax code. Let's say that in our imaginary scenario the first 800 million dollars of income is subject to a 98% marginal tax rate. That means that both Paul and Bill would pay the same amount of taxes on the first $800,000,000 of their income. But Bill would pay more in taxes than Paul because he made an extra $200,000,000 in income. In a marginal income tax system, Bill would pay the 99% tax rate only on that extra $200,000,000. This would leave him with $2,000,000 more in disposable income than Paul would end up with.
What about within a tax bracket? Well, if Warren Buffett grosses $900,000,000 the same year, he would also pay the same amount of taxes as the others did on the first 800 million dollars of their income. He would also pay 99% on the extra $100,000,000 that he earned. This would leave him with $1,000,000 more in disposable income than Paul ends up with, but with still $1,000,000 less than Bill ends up with. The comparative bidding positions of all three men within the hierarchy of national income distribution would be preserved.
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HOW THE RICH CAN REALLY GET RICHER
All of the time, expense, & energy that Rich Republicans have invested in their efforts to get their shared tax 'burden' reduced have been utterly futile. Since all rich people received big gains in disposable income from the Reagan & Bush Tax Cuts, none of them actually benefited in real terms. Instead of seeking to enrich themselves with "Easy Money" through foolish collectivist political schemes, rich people do have the option of improving their financial status The Old-Fashioned Way---i.e., by earning it in the marketplace.
Wealthy individuals can enhance their claims on the scarcest goods & services (become richer, in real terms) by innovating and bringing to market some good or service that becomes so popular with consumers, the income from sales gives them a significant increase in pre-tax income compared to all other rich people. But there is still one thing that rich people can do collectively to increase the real wealth that all of them will enjoy. They can tax themselves at higher rates and then use that money---through their government---to employ additional human resources in the production of public wealth.
Most rich people do not realize that there is an important difference between financial wealth and real wealth. We all understand what financial wealth is, but few understand that money only has value because it gives us a claim on the productive efforts of others. If we were to all somehow become extremely rich in dollars one day, and we all decided that we wanted to retire and live off of our accumulated "wealth", we would soon find that we actually possessed no real wealth at all because no one would be producing anything that we could buy.
A nation's real wealth is its productive output: the real goods & services its citizens are able to produce with their work efforts. The term 'public wealth' does not refer to accumulations of money or financial assets held by the government. In real terms, 'public wealth' normally refers to the valuable services and investments (in infrastructure, human capital) that are generated by government spending. These services and investments are defined as real wealth because they improve the quality of the lives of citizens in real terms.
As rich as he is, Bill Gates cannot personally afford to reduce the traffic congestion he must deal with on the highways, nor the blight that he often sees from them. He can afford to keep his primary living environment clean and healthy, but he can't afford to buy pollution-free air and water wherever he goes. He might feel a certain amount of pride in his ability to keep up the appearance of his own properties, but he can't personally afford the cost of making his city, his state, and his country look equally attractive.
The good news for wealthy individuals like Bill Gates is that they can afford to buy significant improvements in the quality of their lives through their governments. The bad news is that many rich people---perhaps a majority---have historically opposed any and all political efforts to expand the government's production of 'public wealth.' They haven't wanted to give up the purchasing power that they've always been certain they'd have to give up.
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SMART RICH VS. STUPID RICH
There is one more reason why Rich Republicans oppose the government's use of their tax dollars to produce public wealth. They'd prefer to spend the money on their own personal philanthropy instead of using their government to express their generosity. But there is a problem to this 'private' vs. 'public' approach.
As things stand now, rich Americans who act on their generous instincts make a real sacrifice when they choose to give to charities or civic causes. Why? Because those rich people who choose not to give---or to give less---end up improving their purchasing power in real terms---relative to their more generous peers---for no reason other than because they choose not to be generous (or as generous). When you give money to others, it reduces the size of your disposable income relative to the disposable incomes of all other rich people.
Individual acts of charity can re-order the hierarchy of disposable-income distribution in favor of non-givers. This means that individuals face a market-based incentive to ignore the needs of others because they stand to gain a real purchasing power reward if they do so. Rich people who believe that economically privileged citizens ought to help finance the common good should be especially annoyed by this state-of-affairs.
It's not that they aren't willing to make a personal sacrifice if it's needed. They obviously are. It's just that it is difficult to psychically tolerate the continued existence of perverse institutional incentives that reward indifference toward others when it is not necessary.
We have two options. The first one is to set up our tax code so that all rich people are required to be equally generous in contributing to the common good. If this option is pursued, no rich person ends up having to make any material sacrifice. The other option is to continue to allow some rich people to contribute to the common good if that is their desire. This option forces those who are conscientious to pay a material penalty for having done "the Right Thing."
Forcing others to contribute who might rather prefer to enrich themselves at your expense may not sound like such a bad idea, when you think about it. If rich people are able to see that this is the clear choice they face, it should encourage them to see The Government in a new light. Instead of perceiving The Government only as a threat to them, maybe they'd begin to realize that it could actually end up being a very good friend of theirs, an institution worth defending, the KEY to a very desirable future.
After all, The Government is their organization, isn't it? Like all other organizations, The Government may be flawed, but even flawed organizations are able to produce a lot of things that are of great value. It becomes very difficult to demonize an organization that can make a lot of very good things happen for you.
In economics, economic agents are not condemned for being selfish, but only for being stupid-selfish instead of smart-selfish. Those who have advocated lower taxes for wealthy citizens and a reduction in the size of government have been quite foolish in their political aims. They have not only hurt others in their quest for ever larger piles of "dollars", but have also hurt themselves, having deprived themselves of the gains in real wealth [i.e., public wealth] that they would have enjoyed if only they had understood markets better.
If you are a rich person who is Smart-Selfish, you will probably want to start heaping a lot of ridicule on your Supply-Side friends, taunting them for being so incredibly Stupid-Selfish.
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