[FoRK] Tax math

Adam L Beberg beberg at mithral.com
Mon Oct 11 13:01:40 PDT 2010

He has the math about right... the "why bother" factor is a lot more of 
an issue then people realize when it comes to pursuing income for the 
smart/rich set. The motivation to get up in the morning and go work for 
someone else is zero if you're wealthy.

Easy enough to set your salary to $1/year, and not pay any taxes for 
years. About time to get on with starving the beast. A few thousand 
people do that and tax income drops like a rock. (see also, California)



October 9, 2010
I Can Afford Higher Taxes. But They’ll Make Me Work Less.

AN important issue dividing the political parties is whether to raise 
taxes on those earning more than $250,000 a year. Democrats say these 
taxpayers can afford to chip in a bit more. Republicans say raising 
taxes on those who already face the highest marginal tax rates will hurt 
the economy.

So I thought it might be useful to do a case study on one of these 
high-income taxpayers. Fortunately, I have one handy: me.

As a professor at Harvard and the author of some popular textbooks, I am 
comfortably in the income range that would be hit by this tax increase. 
I have been thinking — narcissistically, to be sure — about how higher 
taxes would affect me. Maybe these thoughts can shed some light on some 
of the broader policy issues.

First, I have to acknowledge that the Democrats are right about one 
thing: I can afford to pay more in taxes. My income is not in the same 
league as superstar actors and hedge fund managers, but I have been very 
lucky nonetheless. Unlike many other Americans, I don’t have trouble 
making ends meet.

Indeed, I could go so far as to say I am almost completely sated. One 
reason is that I don’t aspire for much more than a typical 
upper-middle-class lifestyle. I don’t fly around on a private jet. I 
have little desire to own a yacht or a Ferrari. I own only one home, in 
which I have lived since 1987. Paying an extra few percent in taxes 
wouldn’t create a lot of hardship.

Nonetheless, as Republicans emphasize, taxes influence the decisions I 
make. I am regularly offered opportunities to earn extra money. It could 
be by talking to a business group, consulting on a legal case, giving a 
guest lecture, teaching summer school or writing an article. I turn down 
most but accept a few.

And I acknowledge that my motives in taking on extra work are partly 
mercenary. I don’t want to move to a bigger house or buy that Ferrari, 
but I hope to put some money aside for my three children. They will 
never lead lives of leisure, but I hope they won’t have to struggle to 
find down payments to buy their own homes or to send their kids to college.

Suppose that some editor offered me $1,000 to write an article. If there 
were no taxes of any kind, this $1,000 of income would translate into 
$1,000 in extra saving. If I invested it in the stock of a company that 
earned, say, 8 percent a year on its capital, then 30 years from now, 
when I pass on, my children would inherit about $10,000. That is simply 
the miracle of compounding.

Now let’s put taxes into the calculus. First, assuming that the Bush tax 
cuts expire, I would pay 39.6 percent in federal income taxes on that 
extra income. Beyond that, the phaseout of deductions adds 1.2 
percentage points to my effective marginal tax rate. I also pay Medicare 
tax, which the recent health care bill is raising to 3.8 percent, 
starting in 2013. And in Massachusetts, I pay 5.3 percent in state 
income taxes, part of which I get back as a federal deduction. Putting 
all those taxes together, that $1,000 of pretax income becomes only $523 
of saving.

And that saving no longer earns 8 percent. First, the corporation in 
which I have invested pays a 35 percent corporate tax on its earnings. 
So I get only 5.2 percent in dividends and capital gains. Then, on that 
income, I pay taxes at the federal and state level. As a result, I earn 
about 4 percent after taxes, and the $523 in saving grows to $1,700 
after 30 years.

Then, when my children inherit the money, the estate tax will kick in. 
The marginal estate tax rate is scheduled to go as high as 55 percent 
next year, but Congress may reduce it a bit. Most likely, when that 
$1,700 enters my estate, my kids will get, at most, $1,000 of it.

HERE’S the bottom line: Without any taxes, accepting that editor’s 
assignment would have yielded my children an extra $10,000. With taxes, 
it yields only $1,000. In effect, once the entire tax system is taken 
into account, my family’s marginal tax rate is about 90 percent. Is it 
any wonder that I turn down most of the money-making opportunities I am 

By contrast, without the tax increases advocated by the Obama 
administration, the numbers would look quite different. I would face a 
lower income tax rate, a lower Medicare tax rate, and no deduction 
phaseout or estate tax. Taking that writing assignment would yield my 
kids about $2,000. I would have twice the incentive to keep working.

Now you might not care if I supply less of my services to the 
marketplace — although, because you are reading this article, you are 
one of my customers. But I bet there are some high-income taxpayers 
whose services you enjoy.

Maybe you are looking forward to a particular actor’s next movie or a 
particular novelist’s next book. Perhaps you wish that your favorite 
singer would have a concert near where you live. Or, someday, you may 
need treatment from a highly trained surgeon, or your child may need 
braces from the local orthodontist. Like me, these individuals respond 
to incentives. (Indeed, some studies report that high-income taxpayers 
are particularly responsive to taxes.) As they face higher tax rates, 
their services will be in shorter supply.

Reasonable people can disagree about whether and how much the government 
should redistribute income. And, to be sure, the looming budget deficits 
require hard choices about spending and taxes. But don’t let anyone fool 
you into thinking that when the government taxes the rich, only the rich 
bear the burden.

N. Gregory Mankiw is a professor of economics at Harvard. He was an 
adviser to President George W. Bush.

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