IREGBULEM: The cost of making money

The income tax is essentially the government-imposed cost of making money. In other words, if your tax rate is 20 percent, then making $1 costs you 20 cents. As with anything else in life, the higher the cost of something, the less of it you will demand. Therefore, it makes perfect sense that raising taxes (or, the cost of making money) would reduce people’s eagerness to make money, since it essentially makes earning money more expensive.

Despite the simple and obvious truth just described, many people willfully and knowingly argue against something that is undeniably true: Raising taxes causes people to work less, and therefore earn less.

This behavior reflects simple downward-sloping demand, and yet so many ignore it just to satisfy their political leanings. If we can all agree that higher food prices will hurt anyone with some desire to consume food (i.e., everyone), or that higher oil prices will hurt anyone whose life is directly affected by oil production (i.e., everyone), then why can’t we all agree that artificially raising the price of making money is going to harm anyone who makes money and has some level of income (i.e., just about everyone)?

The arguments reach true absurdity when discussing taxation of the rich. The common line of reasoning is that, since the rich have so much money and have such high incomes, they either don’t respond strongly to changes in taxation or simply don’t care. This argument does have some intuitive appeal; it makes sense to think that someone who already has a large amount of something wouldn’t care much if the cost of acquiring even more increased.

However, I find it odd that some of the same people who claim that the rich are not responsive to taxes and are not very much harmed or affected by them will, at the same time, claim that the rich are greedy people who tightly cling to their money and are eager to accumulate even more. One cannot claim that the rich both desperately want to make more money but simultaneously don’t mind having it taken away from them, and yet this is the exact argument made by many who wish to “soak the rich.”

In fact, data shows that the claim that the rich are not responsive to taxes is entirely false. Not only that, the data also shows that higher-income people are in fact the most responsive to taxation of all income groups. A paper written by liberal economists Jon Gruber and Emmanuel Saez in 2000 showed that taxpayers with annual incomes of $100,000 or more had a taxable income elasticity of 0.57, which means that a 10 percent increase in tax rates would lead these taxpayers to reduce their taxable income by 5.7 percent, a sizable reduction. Taxpayers with income below $100,000, however, only had an elasticity of 0.18, meaning that the same increase in taxation would cause them to reduce their taxable income by 1.8 percent. This data soundly destroys the argument that the rich don’t react to taxation.

Now, what is the policy implication? The implication is that, instead of focusing so much on taxing the rich and making them “pay their fair share,” which they already do (the top 1 percent paid 28.9 percent of their income in federal taxes in 2009, whereas the middle quintile of households paid only 11.1 percent), more emphasis needs to be placed on reforming our broken, loophole-ridden tax system. A large amount of this sensitivity to taxation that Gruber and Saez show can be explained by the litany of tax loopholes and exemptions that the rich have access to, along with the accountants they can afford to help them find these tricks. With so many methods of reducing taxable income at the disposal of higher-income individuals and families, it should come as no surprise that they are the best at hiding money from Uncle Sam.

Loopholes and exemptions distort taxpayers’ behavior and the wider economy, as any economist would agree. Many economists also agree that low tax rates levied on a broad base of income earners are the most efficient way to tax income. The rich are just as responsive, if not more responsive to changes in taxation. Until we fix the loopholes, they will respond in force to any increase in taxation, as the data convincingly shows.

Nnamdi Iregbulem is a senior in Davenport College. Contact him at nnamdi.iregbulem@yale.edu .

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