We're conditioned to regard taxation as bad for the economy. Politicians typically either advocate tax cuts or defend taxes as a regrettable but necessary evil. The proposition that higher taxes could spur faster economic growth is anathema in our political debate and flies in the face of current economic dogma. Yet it is not such a farfetched idea.
Consider first the conventional wisdom expounded by, among others, the Club for Growth, a premier think tank whose main goal is to promote economic growth in the United States through low-tax policies. The Club for Growth claims that a progressive taxation system, with those in higher income brackets not only paying more in absolute terms but getting taxed at much higher rates, discourages the ambitious and entrepreneurial from working hard and taking risk. As a result, there is less growth, less innovation and less wealth creation.
Historical evidence seems to support this view. In the U.K. in the 1970s, for example, the top marginal income tax rate sometimes reached as high as 98 percent. At such confiscatory rates, with wealthy taxpayers giving the government 98 pence of every extra pound they earned, the incentive to make more money disappeared. It was also a period of economic stagnation, which ended after Margaret Thatcher reduced taxes sharply.
But a very different scenario could also occur. Imposing higher taxes on the most productive members of society should actually make them work far harder in order to escape the egalitarian income levels imposed by progressive taxation.
Tax rates that leave just 2 percent of your latest earnings in your pockets are obviously overkill, but if the top income tax rate goes up from, say, 30 percent to 60 percent, there will be an incentive for those in the top income bracket to earn two dollars for every dollar they previously earned, so as to keep 80 cents rather than 70 cents. That would mean entrepreneurs work harder and provide a boost to the economy.
What is needed is an opportunity to make that extra dollar. Entrepreneurship, risk-taking and innovation depend on overall economic conditions that encourage them, not just on high or low taxation levels. Relatively high taxes have not prevented innovative economies from emerging in the Nordic countries and Israel. Most people in Sweden pay a tax rate of 50-60 percent when central government and municipal taxes are included, and in Israel the top income tax rate is 45 percent. In Russia, on the other hand, where a flat tax rate of 13 percent has been in place for a decade, the economy has shown no sign of becoming more dynamic or entrepreneurial. On the contrary, small and medium-size businesses have been disappearing and businesspeople have been migrating to higher tax jurisdictions in the West.
In the U.S. the information technology revolution began in the second half of the 1970s, when getting rich seemed extremely difficult since the top income tax rate was a whopping 70 percent. Staying rich was even harder, because high inflation was destroying accumulated wealth while the stock market was stagnant. Nevertheless, the fear of eventually giving Uncle Sam more than two thirds of their earnings didn't keep Steve Jobs and Steve Wozniak from assembling the first Apple computer at a garage, or Bill Gates from founding Microsoft and doggedly fighting to secure for it a near-monopoly on personal computer software.
The info tech revolution reached its peak in the 1990s, before the two rounds of George W. Bush's tax cuts came into effect. The 20th century's final years saw high employment, and even a labor shortage, in the U.S., with kids fresh out of college commanding exorbitant salaries. New entrepreneurial fortunes, provided by such companies as eBay, Google and Amazon, began to be built.
As to the Bush tax cuts, which theoretically should have provided a boost to jobs and generated solid economic growth by freeing job creators of their excessive tax burden, they resulted instead in the creation of a massive housing bubble and a huge speculative pyramid in financial markets and commodities.
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