There is a basic truth in life: you get more of what you subsidize, and less of what you punish. We have subsidized poverty by providing food stamps, WIC, and dozens of other programs to the poor in our decades-long war against poverty. The end result is more poor people. Granted, our poor are the richest poor in the world, but they are still here. On the other hand, if you punish people for an action, they will do it less often. This is the basic idea behind jail time and other just punishments for breaking the law. Taxes work in much the same way. The current progressive tax rates take an increasingly larger percentage of your money the more you earn. In effect, government punishes people for being successful. Is it no wonder that people work harder and make more money, and the economy soars, as the top tax rates are dropped? As the taxes are reduced, the government stops punishing those who produce.
Seems pretty common sense, doesn’t it? But you’d be surprised how many people fail to understand this. The state of Oregon has no sales tax, but Washington, its neighbor to the north, does. The Columbia River separates the city of Vancouver, Washington from the greater Portland area of Oregon. Businesses, especially large-item businesses, are not doing well in Vancouver. They operate at a handicap of over 9% because of sales tax. This means large goods are more expensive in Washington, and it is no wonder that people regularly cross the I-5 bridge into Portland to go shopping. The sales tax in Washington is a disincentive to shoppers. People living in Seattle, on the other hand, don’t have easy access to Portland. So if a family has budgeted $500 for purchases that month, they are only able to buy about $450 worth of actual goods. The extra $50 goes to the government, not to the businesses in the form of extra goods sold, or to the family as $50 worth of extra goods purchased for the home.
“But Captain! Government needs money to pay for the services they provide!” At this point, I’m not going to argue over the merit of any government programs. The merit (or lack thereof) of a government program doesn’t change the fact that taxing a good or service effectively discourages purchase of that good or service. Don’t believe me? Whenever the cost of gas goes up, people adjust their lifestyles accordingly. The last time gas broke the $2 per gallon mark, there were news stories about gas stations seeing a drop in sales (duh!), and people making plans to take vacations locally rather than driving long distances (duh!). These aren’t news stories; this is simply a common-sense reaction to rising prices. We saw exactly the same thing during the gas crisis of the late ’70s.
Let’s imagine a state with a flat income tax of 10%, and a nearby state with a flat income tax of 90%. Do you think people would move from the second state to the first just to keep more of their hard-earned money? You bet they would, faster than you could say “1040EZ!” Why? Because people want to keep more of their own money. So what happens when the entire nation adopts a flat tax of 90%? Some people will doubtless leave the country. But since not every American wants to leave the U.S., people will stop working so hard. Why should these hard-working people bust their butts every week just to see the government scrape 90 cents off every dollar they make? Oh, sure, some people will still make millions even with an income tax rate in the 90s, but a high tax rate does tend to suppress the natural incentive to work hard. Or if it doesn’t suppress the desire to work hard, it certainly inspires people to hide their money from the government as best they can through tax loopholes and shelters.
When taxes are high, lobbyists put greater pressure on the government to create special loopholes for their rich clients. But when tax rates are low, people don’t feel the need to hide their money as much. Why should they spend the time and money hiring tax lawyers and professionals to shelter their money when the rates are low? Each time the tax rates have dropped, the end result is an increase in government tax revenue.
This whole discussion of taxes can be confusing since people use the terms “tax cut” and “tax rate cut” interchangeably. In most of this comment I have been talking about a tax rate cut. This is what President Reagan did when he proposed dropping the top rate from 70% down to the 20s. When a tax rate is lowered, the actual amount of taxes received by the government goes up. This seems counterintuitive, but it has worked every time it has been tried. When the government lowers tax rates, this repressive weight is lifted, and the people are rewarded better for their work. Since people can keep more of what they make, they will be more inclined to work harder and increase their incomes. The government may be taking a smaller percentage of the economic pie, but since the overall pie has grown, the government’s slice is bigger than before. Additionally, the government will get more taxes from people who don’t mind paying a smaller percentage of their overall income. When the tax rates are low, you won’t hear radio ads like the one I heard this morning while driving to work. A tax preparation company claimed to reduce income tax as low as possible, and it signed off with the jingle, “When you care enough not to send your very best.” Can you imagine a world where it wouldn’t be necessary to hire people to do your taxes, and there were not entire industries centered around trying to pay the government as little as legally possible? Imagine what could be done if all these efforts could be harnessed to create something useful!
I find it ironic that the United States has a progressive tax similar to that recommended in the Communist Manifesto, and the former Soviet Union has adopted Steve Forbes’ flat tax.