Sunday, September 19, 2010

Soaking the moderately rich

Much fun in the blogosphere today, as Brad DeLong links us to a couple of posts by law professor Todd Henderson, who is
complaining that his family's $455,000 income would be severely strained by the repeal of the Bush tax cuts. DeLong first sends us to Michael O'Hare, who mocks Henderson for being a poor-little-rich-boy who whines about making 9 times the U.S. median income. After Henderson calls DeLong "Deling" in a reply, the infuriated Deling goes on an epic rant, pointing out that Henderson is probably just upset because he's comparing himself to people even richer than himself. Deling then notes that Henderson wasn't exactly screaming bloody murder when Bush cut taxes in 2001, a move which ballooned the deficit and ensured that higher taxes would be needed in the future. After this epic beatdown, Deling transforms back into his alter ego, the mild-mannered Dr. DeLong...

Fun stuff.

I tend to be somewhat ambivalent on the issue of whether Henderson's consumption would take a meaningful hit if his taxes went back to 1999 levels. I mean, were people with $455,000 incomes really forced to scrimp and save in 1999? I doubt it. Then again, Henderson is perfectly within his rights to say that moderately-rich people are people too, and they are used to the lifestyles they've been living. To tell them they can be happy with less is a bit like telling people "Hey, your parents were perfectly happy back in 1980, so give us your iPhone because you obviously don't need it to have a good life." Consumption habit formation is a real phenomenon, and rich people's utility is real utility.

Of course, all this is beside the point. As "Deling" points out, Bush cut taxes and raised spending, and now there's nothing to do for it but raise taxes and cut spending to avoid a disastrous explosion of debt. Henderson may be right that higher taxes will cramp his lifestyle, but who would he suggest is in a better position to bear the burden? Someone who makes $50,000 a year, perhaps?

The moderately rich are not being soaked by socialists. They soaked themselves (well, more than half of them, anyway) by voting Republican in 2000 - by taking short-term gratification in the form of unsustainable tax cuts. They should have been smart and avoided the pain that would inevitable come from discovering that their lifestyle wasn't sustainable. But they were not smart.

(Anyway, I'd like to close with a side note, about something that has always bugged me. In these tax discussions, many of the moderately rich people who complain about higher tax rates seem to think they earn more money than they do. This is a basic economics error, and it's called "failure to understand tax incidence." Let me explain. Henderson seems to think that, because his pretax income is now $455,000, that if his tax rate went to zero he would take home $455,000 in his pocket. This is just not the case. If Henderson didn't have to pay income tax, his employer could afford to hire him for a lower pretax salary.

How much lower? That depends on two things: 1. the elasticity of Henderson's labor demand (i.e. how easily his employer can replace him or do without him), and 2. the elasticity of his labor supply (how much of a salary cut he is willing to take before he quits). If Henderson thinks that he could take home $455,000 in a zero-tax world, he is assuming that he's absolutely irreplaceable, but could easily find another equally good job if he wanted. Sorry, Todd, you're awesome, but you are just not that awesome.

So to reiterate: if you "pay $100,000 in income tax," you're actually only paying part of that. Your employer is paying the rest. Just one more reason the moderately rich aren't getting soaked as badly as they seem to think they are.)


  1. Worth noting another consequence of the salary phenomenon you mentioned: If Henderson didn't pay income tax and his employer could hire him for much less, the employer could also hire more employees and get more work done. From the perspective of the taxpayer, the tax is economic inefficiency. (The legitimate followup question is whether politicians are likely to use that money more efficiently than the employer would have--but that question seems to be chronically overlooked.)

  2. Chrylis: You're right. I didn't discuss efficiency issues in this post. To discuss that, I'd have to take into account at least two other things:

    1. The relative inefficiencies of higher taxes vs. a future U.S. sovereign debt default

    2. The relative inefficiencies of raising taxes vs. cutting spending

    Those are important and complicated issues.