Small Matters: Don't make the mistake of overtaxing wealth

Posted: November 07, 2011

I once had the opportunity to spend a weekend with J. Paul Getty (yes, Getty Oil) at his place in England. One of the Gabor sisters was there, and I never felt good sitting on the furniture, which was clearly old and, I am sure, valuable. I was young and poor and had just graduated from college.

No debts. I worked many jobs, but had no assets either. A Getty sofa would have been nice.

Not long after my visit, Britain decided it needed more tax revenue, and it levied a wealth tax on its citizens. I don't remember the details. What I do remember is that J. Paul Getty moved to California and took his wealth with him, much to the benefit of Southern California. Visit the Getty museums he built in Los Angeles, if you have a chance.

Seems like we never learn. There is now a similar move afoot in the United States. The "rich" are now the enemy, blamed for our ills, castigated for making too much money. There are proposals to take money from the rich and give it to others, who will spend it all and allegedly provide a stimulus for the economy.

Saving is not valued by these tax-the-rich proponents. Our savings rate is so low now that we must borrow trillions from the rest of the world to finance our investment in plants, equipment, and even housing.

Tax the wealth, and it will move. And all the investment and job creation it produces will move with it.

Of course, defining "rich" is a problem. My brother is poor by U.S. Census Bureau definitions because his cash income is low. But he had houses on Lake Michigan and in Florida and a boat and marvelous cars. There is a difference between income and wealth. The rich, based on income, pay a lot of taxes. The top 1 percent earn 20 percent of all U.S. income, but pay 40 percent of all income taxes paid and more than 25 percent of all federal taxes collected.

To be in the top 1 percent, you must earn about $350,000 annually, and $150,000 puts you in the top 10 percent.

The lowest 50 percent of all taxpayers pay only a few percentage points of the income tax (but receive huge amounts of government services, and they do pay Social Security taxes).

Dividends are taxed twice now: once when the company pays taxes on profits and once when the dividend recipient receives the dividend income (thus the logic behind a lower tax rate on dividends, so Warren Buffett really does pay a higher rate on his dividend income).

The tax code is a mess. So, once again, the "flat tax" is gaining popularity. We spend an estimated six billion hours filling out tax forms and keeping records, and a majority must pay for professional help to give Uncle Sam his due. Seems unreasonable.

A flat tax would work something like this: There would be no deductions for anything - not charity, mortgage interest, or a host of other special stuff in the tax code today. There would be only personal exemptions (like now), say $30,000 for a family of four, less for single individuals.

Your tax would be a percentage of your income in excess of the exemption. If, for illustration, the tax rate were 20 percent, then your tax would be 20 percent of your income, minus the exemption.

For example: If you earned $31,000, and you were a family of four with an exemption of $30,000, you would pay $200 in income tax: $31,000 income, minus $30,000 exemption, equals $1,000 times 20 percent, or $200. That would be less than 1 percent of your income.

You would owe no tax if you earned less.

Someone with a family of four and earning $1 million would get the same $30,000 exemption but would pay a tax of $194,000, or 19.4 percent of his income.

A flat tax would be a boon for millions of small businesses, reducing the amount of time and money owners had to spend to deliver tax revenue to the government.

Here is the advice from the magazine the Economist: "There is a basic bargain to be had. Imagine a tax system which made the top rates on wages and capital more equal, and which eliminated virtually all deductions. To avoid taxing investments twice, such a system would get rid of corporate taxes. It would also allow for a much lower top rate of income tax. The result? A larger overall tax take from the rich, without hurting the dynamism of the economy."


Bill Dunkelberg is a professor of economics at Temple University and a nationally recognized expert on the small-business economy. Contact him at dunk@temple.edu.

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