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On the Economy

Don't worry, rich people will keep making money despite higher taxes

Conservatives argue that a tax raise for the rich will discourage them from creating more wealth for everyone else. Here's why they're wrong.

By Jared BernsteinGuest blogger / September 1, 2011

Investor Warren Buffet arrives for the premiere of the film "Wall Street: Money Never Sleeps" in New York. In a recent New York Times op-ed, Buffet argued that the tax code "coddles the rich."

Lucas Jackson/Reuters/File

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I was just listening to a debate on tax policy on the radio, riffing off of Warren Buffett’s great op-ed from last week on how the tax code “coddles the rich.” The conservative—doesn’t matter who; he was just running the talking points—made these arguments: 1) the rich pay most of the federal income taxes; 2) If Buffett or anyone else wants to pay more taxes, they should go ahead and do so; 3) the rich create the jobs, the wealth, the gov’t revenue—if you tax them more, they’ll create less of all that.

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#2 is just silly.

#1 is true, but the thing to remember, and a central point of Buffett’s piece, is that they’re actually paying a considerably smaller share of their income in federal taxes than a) they have in the past (see slide #4 here) and b) then lots of other people with a lot less income. Buffett notes that his 17% effective tax rate is about half the average rate for the rest of the people in his office.

But it’s point #3 I’d like to rage about here for a second. One of the themes I’ve consistently come back to on these pages is the extent to which advocates go way beyond the evidence in assigning huge behavior changes to even the slightest changes in the tax code.

But the thing I and others don’t mention enough is that in theory, there’s no reason to expect people to respond to higher tax rates by working less. That is, they could just as easily decide to work harder to make up the loss in their after-tax income.

Microeconomics predicts two responses to higher taxes on the work effort of people. Response A is that they work less, because the “price,” or opportunity cost, of non-work, just went down…you lose less if, once your after-tax wage has gone down, you work less.

But the other response (B) is that you work more to make up for the lost income.* And there’s no reason, a priori, to think response A dominates response B. If anything, the literature, which tends to show small responses to tax changes, suggests the two responses offset each other.

In other words, we would be wholly (holy?) justified to argue that we need to raise taxes on upper income people so that they’ll work harder!

*Interestingly, conservatives often argue that B dominates among the poor—cut their income from say, reducing the benefits from a welfare program, and they’ll work harder. That’s much the same argument as response B above.

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