As Congress wrestled with the debt ceiling this summer, many commentators argued for tax increases, and specifically for the wealthiest Americans to pay more. As often as we hear the refrain of taxing the rich, one would think that the Federal government could eliminate its red ink by raising taxes modestly on the rich or super rich. But it just isn’t so.
One reason taxing the rich won’t end budget deficits is that the wealthiest Americans already pay a lot of taxes: In 2008, the top 1% of households paid 38% of Federal income taxes. A second reason taxing the rich won’t work is because government spending dwarfs the wealth of the richest Americans. Even taxing away all of the wealth of America’s billionaires would fund the Federal government for only about four months.
To arrive at this figure, I consulted Forbes’ list of the 400 wealthiest Americans for 2010. The threshold for making the top 400 was $1 billion in wealth, so this serves as the billionaires’ list. Forbes estimated each of these individuals’ wealth, and the 400 billionaires together had a net wealth of $1.37 trillion, led by Bill Gates at $54 billion. Obviously these estimates will contain some errors, some of which will cancel out, and so I use this total net worth estimate. Federal spending in fiscal year 2011 was $3.82 trillion, or $10 billion per day. America’s billionaires are very wealthy, but all of their wealth would keep the Federal government going for only 131 days, or a little more than four months.
Taxing away all of the wealth of America’s billionaires would come close to eliminating the Federal budget deficit – but just for one year, and could only be done once, as afterward the billionaires would no longer be billionaires, or even millionaires. Taxing the billionaires’ income instead of wealth could be sustained over time but would yield only a fraction of this amount in revenue, enough to fund the Federal government for a matter of days.
And taxing away the billionaires’ wealth wouldn’t be a wise policy, even if it could balance the Federal budget. Although one might guess that the ranks of America’s billionaires are full of Rockefellers, Fords, Kennedys and Vanderbilts, many of the nation’s wealthiest citizens have earned their wealth from relatively new companies that have changed the shape of the U. S. economy over the past several decades, led of course by Bill Gates and Microsoft. Wal-Mart built the fortunes of three of the richest 10 Americans. Other billionaires have earned their fortunes building companies like Apple, Dell, Nike, Oracle, Google, Facebook, and Home Depot. The wealth America’s billionaires helps them continue to expand these (and other) businesses, to the benefit of all of us. Capitalism produces a virtuous feedback process: Individuals who prove their ability to create value receive profits which they can use to do more beneficial things for the economy.
Taxing away the wealth of the richest Americans would have a disincentive effect. Marginal tax rates affect peoples’ incentive to work hard, find new jobs, and start new businesses; this is why economists stress the importance of lowering marginal tax rates. But a modest increase in marginal tax rates, say from 35% to 40%, doesn’t prevent one from getting rich by building a successful business. Most of America’s billionaires have built their wealth over a lifetime of hard work (and paid millions in taxes along the way). Paying a few cents extra in taxes on each dollar earned reduces the return to hard work, but leaves lifetime goals attainable. Seeing the fruits of a lifetime of work by the most successful among us being taxed away would eviscerate the incentive to build successful businesses.
Proposing to solve Washington’s deficit woes by taxing the rich may win applause. The reality is that Federal government’s addiction to spending is a habit that even the wealthiest Americans cannot afford to support for long.
Daniel Sutter is professor of economics at Troy University’s Johnson Center for Political Economy