There are a lot of sound bites and meaningless phrases used to cover the debate on fiscal reform.  “Fiscal Reform” means cutting expenses for some, increasing taxes for other.  I think I will scream if I hear the phrase ‘fiscal cliff ‘ one more time.  I write to clarify my own thoughts and that motivated A Tax Increase Primer published at American Thinker:

The estate tax is particularly attractive to social progressives but it has some very undesirable effects. We all benefit from a long-term investment view, a view that often extends well beyond a single generation. This is true whether you own a working farm or a factory. This creates and preserves capital for economic growth and job creation. The estate tax encourages a very short-term perspective.

If you knew that at the end of every year you would have to pay a tax of 50% on assets you have saved during the year, what would you do? Likely, you would minimize your savings, spending more, and saving and investing less. You would not have to pay a tax on the enjoyment of a better lifestyle.

The wealthy are no different. A high estate tax creates an incentive for conspicuous consumption over investment. While they will use whatever expensive legal tax avoidance schemes are available, we all suffer from the smaller investment pool.

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While mentioned in that article I further examined the incredibly regressive nature of the taxes for those at the lower end of the earnings curve. Regressive Marginal Tax Rates :

Those at the bottom of the income ladder who draw government transfer payments stand to lose those transfer payments if they earn more than a very limited amount.  If a worker who is unemployed receives $10,000 in transfer payments stands to lose those payments if they earn $20,000 then that low income worker is subjected to a marginal tax rate of 50%, higher than our highest rate for earned income.

While we focus on a single rate such as the federal income tax, our incentive to earn is formulated from the accumulation of all taxes and friction costs.  For a new entry into the workplace these friction costs include transportation costs and suitable clothing, baby sitters, and the loss of leisure time.  The total tax burden includes state and local taxes, FICA, Medicare and taxes and addition consumption taxes required for the job.

The high marginal tax rates for those at the lower end of the income scale increases dependency and stifles incentive to work.  It is not the lower rate on the upper income that should outrage Warren Buffet; it is the much higher rate we impose on those trying to leave dependency.

While the progressives appear fixated on raising the rates on the wealthiest we see over and over that these fail to bring in the revenue they intend. From Lessons Unlearned (Quote is from Robert Winnett article in The Telegraph):

In the 2009-10 tax year, more than 16,000 people declared an annual income of more than £1 million to HM Revenue and Customs.

This number fell to just 6,000 after Gordon Brown introduced the new 50p top rate of income tax shortly before the last general election.

The figures have been seized upon by the Conservatives to claim that increasing the highest rate of tax actually led to a loss in revenues for the Government.

It is believed that rich Britons moved abroad or took steps to avoid paying the new levy by reducing their taxable incomes.

Far from raising funds, it actually cost the UK £7 billion in lost tax revenue.

The wealthy will flee high tax states within a country.  From Ducking Higher Taxes – Oregon’s vanishing millionaires (12/21/10):

One reason revenues are so low is that about one-quarter of the rich tax filers seem to have gone missing. The state expected 38,000 Oregonians to pay the higher tax, but only 28,000 did. Funny how that always happens. These numbers are in line with a Cascade Policy Institute study, based on interstate migration patterns, predicting that the tax surcharge would lead to 80,000 fewer wealthy tax filers in Oregon over the next decade.

The tax wasn’t enacted into law until June 2009 but was retroactively applied to January 1, 2009. So for the first half of the year wealthy Oregon residents weren’t able to take steps to avoid the tax ambush because they didn’t see it coming. This suggests that a bigger revenue loss from tax mitigation strategies will show up on tax return data in 2010 and 2011. The Revenue Office has already downwardly revised tax collection projections for the first three years by one-third.

If Salem officials want to find where the millionaires went, they might start the search in Texas, the state that leads the nation in job creation—and has a top income and capital gains tax rate 11 percentage points lower than Oregon’s.

The problem with this obsession with a “fair” tax system is that it fails to address the real problem.  A government that proposes to address all of our problems will only disappoint everybody.  Once again from the American Thinker article, A Tax Increase Primer:

 Consistency in tax and regulatory policy may be even more important that having the lowest possible rate or the friendliest possible regulations. Fear and uncertainty, fed by record deficits and endless class warfare speeches, can do as much to squelch investment as the laws themselves.

We also dilute the effect of a single tax increase when we look at it in isolation. Behavior is impacted by the sum of all of the taxes levied: state, local, FICA, and Medicare as well as the friction costs of mandates and regulations. A small increase in a number of different taxes can slow economic growth as quickly as fewer larger tax increases.

An effective tax system should be simple and not subject to change every time an elected official steps up to a microphone. The most effective tax system we could devise, however, cannot overcome the economic and social problems of a government that has grown too large and consumes too much of our productive effort.

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