Paul L. Caron

Saturday, March 26, 2011

WSJ: The Price of Taxing the Rich

Wall Street Journal, The Price of Taxing the Rich, by Robert Frank:

Nearly half of California's income taxes before the recession came from the top 1% of earners: households that took in more than $490,000 a year. High earners, it turns out, have especially volatile incomes—their earnings fell by more than twice as much as the rest of the population's during the recession. When they crashed, they took California's finances down with them.

Chart 2 New York, New Jersey, Connecticut and Illinois—states that are the most heavily reliant on the taxes of the wealthy—are now among those with the biggest budget holes. A large population of rich residents was a blessing during the boom, showering states with billions in tax revenue. But it became a curse as their incomes collapsed with financial markets. [click on chart to enlarge]...

As they've grown, the incomes of the wealthy have become more unstable. Between 2007 and 2008, the incomes of the top-earning 1% fell 16%, compared to a decline of 4% for U.S. earners as a whole, according to the IRS. Because today's highest salaries are usually linked to financial markets—through stock-based pay or investments—they are more prone to sudden shocks. The income swings have created more extreme booms and busts for state governments. ...

Chart 3 Tax experts say the problems at the state level could spread to Washington, as the highest earners gain a larger share of both national income and the tax burden. The top 1% paid 38% of federal income taxes in 2008, up from 25% in 1991, and they earned 20% of all national income in 2008, up from 13% in 1991, according to the Tax Foundation. "These revenues have a narcotic effect on legislatures," said Greg Torres, president of MassINC, a nonpartisan think tank. "They become numb to the trend and think the revenue picture is improving, but they don't realize the money is ephemeral."

Kicking the addiction has proven difficult, since it's so fraught with partisan politics. Republicans advocate lowering taxes on the wealthy to broaden state tax bases and reduce volatility. Democrats oppose the move, saying a less progressive tax system would only add to growing income inequality. [click on chart to enlarge]

Chart 1 

Wall Street Journal, The Battle Over the Millionaire's Tax, By Robert Frank & Laura Saunders:

In the partisan fight over taxing the rich, state "millionaire's taxes" have emerged as the latest and most hotly contested battleground.

In New York, New Jersey, Maryland, Oregon and California, state governors are at war with legislatures over taxing their state's highest earners to plug revenue gaps. Advocates of the taxes say that with the wealthy riding the recovery of stock markets and global growth, and with less fortunate Americans facing unemployment and a housing slump, the top earners can best afford to foot the government's bills. Opponents say the taxes amount to a redistribution of wealth and encourage runaway government spending.

Polls show that many voters support taxing the top 1% or 2% of earners in each state. ... Yet so far, the calls for hiking taxes on top earners have fallen flat at governor's offices and state legislatures. ...

Though attractive to voters and many Democratic politicians, millionaire's taxes carry risks. Because the incomes of top earners are the most volatile, such taxes are among the most unstable sources of state revenue. ... Some also argue that special taxes on the wealthy can drive the highest-earners to lower tax states.

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How about tax the rich and cut spending for the poor-both the rebukeicans and dumbcrats would never agree to that-and support the hard working middle class-novel idea.

Posted by: Nick Paleveda MBA J.D. LL.M | Mar 27, 2011 9:15:49 AM

Volatility of "high" income earners is something I saw up close and personal. Friends of mine, tax attorneys, work at "TARP banks" and they get paid a "modest" amount (approximately $100k) as salary (fixed) and the rest as company stock. Lets say a total compensation package was $250k, therefore $150k was paid in stock. The stock was at about $50/share when paid so do the math on how many shares they got. When the market plunged and TARP bank stock was worth $2-5/share their compensation changed dramatically. ($150k become $15k or less.)

There is no moral here, just a story.

I know it is hard for some people to understand that $100k is not a lot of money in NYC, but cost of living from Washington to Boston is wildly different than most other areas of the country. As someone I know just said, "Why should I move back from Austin where $40k is a living to the east cost where $40k is me living in my parents' basement?"

Posted by: tax guy | Mar 26, 2011 1:09:10 PM