State and local governments are facing a fiscal crisis because of the coronavirus. Due to shutdown orders, businesses have stalled or collapsed. As a result, sales tax revenue has decreased and income tax revenue is expected to be lower as well. On top of that, unemployment claims have increased, and some states are resorting to borrowing from the federal government to cover these costs. And states will need money to cover healthcare costs connected with controlling the spread of COVID-19.
In response, some states have called for increasing taxes on the wealthy. In New Jersey, the income tax rate on those earning more than $1 million will increase to 10.75%, from 8.97%. In New York, a “temporary” millionaire’s tax enacted in 2009 was extended last year until 2024. Legislators are now considering another millionaire’s tax to cover budget holes related to COVID-19. California, whose affluent residents already pay the highest marginal income tax rate in the country at 13.3%, is also considering another millionaire’s tax. In addition, there is a proposed tax increase on the November ballot by adjusting property taxes based on market value for properties worth more than $3 million. A total of nine states are considering some form of surtax on high-income residents.
Taxes are indeed the lifeblood of government, particularly during an economic crisis. But is it good policy to tax the rich during a recession? Here are a few reasons why some people think it is a good idea.
First, rich people are not likely to miss the extra money paid to the government. This is what economists call the diminishing marginal utility of money. It basically means the more wealth you have, the less likely you are to appreciate or need additional income. So if a rich person is not going to value additional income, why not give it to the government who will use it to benefit society?
This theory is somewhat flawed. Look at rappers flexing a lot of bling in their videos. Or people who live a supercharged paycheck-to-paycheck lifestyle because they have to use all of their money to maintain their luxury lifestyle. Or some people have so much high-interest debt that they cannot enjoy (or get utility from) their income for a long time. I’m not making a lifestyle judgment call, but for them it will take a lot more income before the usefulness of money starts to diminish.
And for some people who save money like Scrooge McDuck, they have the utility of more options. They can do more things and not have to worry about burning bridges or being cancel cultured. In my opinion, that kind of utility is immeasurable.
Another argument is that the economy does better when rich people paid high tax rates. The people who support that argument commonly cite to the 1950s when the top tax rate was at 91%. Also, the economy boomed when the top tax rates went to 39% during the Clinton and Obama administrations.
The truth is that only a few people paid those extremely high tax rates back in those days. And even those subject to that high tax bracket rarely paid it due to deductions and other loopholes. It has also resulted in many taking advantage of tax avoidance strategies.
Some have argued that rich people should be taxed more because it is very likely that somewhere along the line, they must have done something (or many things) wrong to get to where they are financially. As we live in a competitive society, these people cheated to get an edge. They might have been dishonest. They might have stolen from people. They might have taken advantage of someone or ruined someone’s career. On that assumption, they should pay more in taxes as penance.
I find this argument generally ridiculous. Now I wouldn’t be surprised if every Fortune 500 company has some skeletons in their corporate closet that they are loathe to discuss at their annual shareholders meeting. But people should be punished individually for whatever they did wrong and should compensate the person who was wronged. The government should not benefit from someone’s wrongdoing to another individual.
Finally, taxing the rich is the easiest solution for politicians. It’s easier than cutting social welfare programs or laying people off. Rich people are easy targets politically since they are a small fraction of the voting population and people don’t mind voting for a tax that they don’t have to pay. It’s easier for politicians to placate their constituents by blaming rich people for not paying their “fair share,” whatever that means. They and their media friends say that the money is needed for schools and road maintenance. And as mentioned above, so-called “temporary” taxes end up being extended again and again.
The rich complain and threaten to move to a state with lower taxes. Governments of popular cities and states know that while the wealthy will talk a big game about moving elsewhere, few will do it. They know the rich won’t leave sunny California to a state with a lot of humidity and yearly hurricanes. Sure, New York City or Los Angeles is expensive, but will they really move to some quiet suburb with lower taxes, less traffic, and funded police who will be more than happy to put violent rioters in their place?
These days, the threat of moving is getting serious. With more people working virtually, they do not need to live in an expensive area to be close to work. Others have to move because of unemployment or other misfortune. Rent prices in high cost of living cities like San Francisco have dropped significantly. Some people, like Gov. Cuomo of New York know this which is why he does not support a new millionaire’s tax.
With government funds running low, it is tempting to tax millionaires because supposedly they are not paying their fair share. But once someone gets into these top tax brackets and see close to half their income go toward taxes, they will want to know the value they are getting for their money. If they are not happy with the answer, or are sick of hearing “schools and roads” they will either move to a low-tax jurisdiction or engage in tax avoidance strategies.
Or they might just pass on the tax to the little people.
Steven Chung is a tax attorney in Los Angeles, California. He helps people with basic tax planning and resolve tax disputes. He is also sympathetic to people with large student loans. He can be reached via email at sachimalbe@excite.com. Or you can connect with him on Twitter (@stevenchung) and connect with him on LinkedIn.