How America was Tricked on Tax Policy. Bret N. Bogenschneider
taxes levied in the United States are not progressively indexed.21 For labor income, a worker may often pay federal income taxes of up to 38 percent, plus state and local income taxes, often 6 percent, plus Social Security and Medicare taxes. That’s roughly 60 percent. And then, once the worker pays the 60 percent in taxes on earned income, lots of other taxes are also required to be paid, like sales taxes (often 6 percent on purchases), property taxes, (typically 3–5 percent of average earnings), gasoline tax (typically 2 percent or more of average earnings), a host of government fees (ranging from 2 percent to 5 percent of average earnings), and on and on. If all these taxes are added up, then nearly everything the worker earns is transferred back to the government in one form or another. If a worker has something left over after paying all these taxes, it should really be considered something of a miracle. One of the most significant deceptions in tax policy is encouraging workers to think that the wealthy and large corporations also pay confiscatory rates of tax similar to how workers pay taxes on their earned income. A second deception is to encourage workers to think that some progressivity in the income tax rates means that they are not paying a rate equal to that of a higher-income person; that is simply false. Wealthy people are wealthy in part because they tend to hold assets that have seen great increases in value, but they are not taxed on those increases as if they were income earned by and through work.
Deception #8. There are no social costs to high taxes on workers
The economic theory of taxation might sound complicated, but it’s simple, really. Economic theory posits that only high-income workers and firms will choose to produce less economic output if they are taxed. This posited reduction in economic output is referred to as the deadweight loss of income taxation.22 The deadweight loss from taxation is a subtraction to economic activity and to tax collections from the taxation of the wealthy only—there is no corresponding deadweight loss from the taxation of working people posited in economic theory. Thus, although evidence for the deadweight loss is lacking, it is posited to accrue only for the wealthy, not for lower-income workers. The assumption is that no matter how much tax workers are required to pay, there is no reduction in economic output from those taxes on workers. In other words, as far as economics is concerned there are no social costs to high taxes on workers. Workers simply don’t count in economic theory—exactly as Thomas Malthus said long ago.
Economics has not changed much since Malthus’s time. We have today really a formal way of applying Malthusian theory through the tax system. A significant problem in the present day is the lack of data to support these economic ideas. Scientists often call data evidence. To see if something is true, scientists like to look at data or evidence. For nearly all economic conclusions about tax policy, the data suggest the opposite result from the one proposed by economic theory. What does that mean? Often those economic conclusions are not supported by empirical evidence, and are sometimes just plain wrong.
It turns out that taxing workers at high rates creates a negative social cost. There should be a subtraction to economic output in economic theory representing a deadweight loss from labor taxation, but there isn’t. These social costs from worker taxation relate to various areas including
•Public health—Workers seem to get sick more often and require costly health care under high-wage tax regimes. The negative economic result occurs because costs of health care are quite high because another person or governmental entity must pay for the incremental health care costs resulting from taxing labor at high rates that might be avoided simply by reducing the tax rates on workers.
•Child outcomes—Workers often have children, and high taxes on workers means they have less to invest in their children. A system designed to tax parents is an expensive design because society must try to remediate any deficits that occur amidst the chaos and uncertainty of parenting on a shoestring budget.
•Reduced or eliminated small business activity—The high tax rates on workers apply also to small businesses, including most types of entrepreneurial activity. Since the tax rates are exceptionally high on small business activity, this is detrimental to the formation of small business and tends to favor large corporations in the marketplace where small business operates in competition with large corporations.
It is very important to note that the point of this book is not that high tax rates on workers are unfair. Rather, the key observation of this book is that high rates of wage taxes are expensive (or inefficient) because taxing workers creates social costs that may even exceed the amount of tax collected.
Deception #9. Workers and poor people are cognitively inferior to the wealthy and unable to make rational economic decisions
The idea of the cognitive inferiority of the poor arose in the subfield of economics referred to as behavioral economics. Although behavioral economists don’t say explicitly that the poor are not as intelligent as the wealthy, their analysis is always premised on that assumption. Rich people are presumed to be smart and able to make rational decisions in the manner economists expect. Of course, the first decision that all presumptively rational and wealthy people make is that they should pay $0 in taxes and that workers should pay all the taxes. The further implication is that the wealthy should make all economic decisions since they are able to think rationally. Notably, this was exactly Thomas Malthus’s view, so today’s economic theory has reverted to an overtly Malthusian ideal.
I wish to challenge here the views both that workers are not rational and that the wealthy are rational or at least more often rational than the poor in decision making. To do so, I need to first disprove the claim that workers or the poor are irrational under the framework of behavioral economics. That’s easy.
To my knowledge, there is no empirical data whatsoever about consumer preferences as applied in the field of behavioral economics related to taxation or tax policy that would allow for the creation of a welfare function. The absence of data means in the context of taxing sugar-sweetened beverages, for example, that it may be true that poor people make a bad decision in drinking sugar beverages, the badness of that decision to consume sugar in economic terms is always relative to cost. Economists call this relativity of cost to choice the welfare function. All economics depends on these welfare functions—they account for much of the field of economics. The basic assertion in behavioral economics is that the poor person spends $0.50 on a sugar beverage and gets back 2 utiles, or some other amount, of welfare. The number of utiles is arbitrary. We only know for sure that it would be irrational for a wealthy person to consume a sugar beverage. We know absolutely nothing about whether it is “rational” (as economists often say) for a poor person to whom price is important to consume a sugar beverage given the respective cost of $0.50. For the wealthy person, the $0.50 is not a material amount of money. A wealthy person could get the same 2 utiles of welfare by choosing a non-sugar-sweetened beverage that costs $4. The difference in price between the $4 and the $0.50 ought to mean nothing to the wealthy person in economic terms. But the difference in price does potentially mean something to the poor person, who might be forced to choose between the $4 beverage and some other consumer item that costs $4 and which also yields welfare of an equivalent amount. To a poorer person, perhaps earning minimum wage, $4 is a lot of money and reflects roughly the value of an hour’s work after tax withholding. Our economist friends have simply never studied the significance of that difference in price relative to cost, so it’s all conjecture. In fact, there is no welfare function, or even any attempt to create a welfare function, for either the wealthy person or the poor person within behavioral economics. All we have in behavioral economics reflects the prejudices of the economists telling us their conclusions without any attempt to provide data. Behavioral economics is essentially economists looking in the mirror and not liking what they see very much.
Second, the wealthy do not seem to act rationally, at least much of the time. The wealthy eat foie gras, collect private jets, build private yachts at ruinous expense, travel by dangerous helicopters, acquire multiple mansions and houses—none of this is rational economic behavior that works toward increasing aggregate wealth. The spending of vast fortunes on personal comforts does not