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August 28, 2011 / Gabriel

Proposed Taxes on “Millionaires” a Bait and Switch Tax on the Middle Class

There’s a lot of talk these days from some politicians about an increase in the income taxes of “millionaires and billionaires.”

Whether that’s good policy or not, there’s a huge difference between the class warfare rhetoric and the economic reality of the proposals, a combination of economic ignorance by many who support such a tax increase and the politicians willing to deceive them in order to actually increase taxes on the middle class.

The first clue that not all is as it seems is that “millionaires and billionaires” are curiously defined down as being individuals making $200,000 or couples making $250,000 annually. Or not so curiously, if you understand the distribution of income:

As this annotated chart from the Wall Street Journal shows, there’s not all that much money above the $1 million mark, and much of it is already heavily taxed. You could in fact confiscate 100% of the income of all millionaires and above this year and at $938 billion it would hardly make a dent in the national debt.

No, the real money in this country is in the middle, and that’s precisely what the proposed tax on “millionaires and billionaires” is intended to target.

But how? Even at a threshold of $200,000 for individuals and $250,000 for couples, it would appear that the tax would only impact the upper range of the income distribution, not the bulk of the middle class.

And therein lies the dirty trick: wage inflation.

Every year, average incomes rises from a combination of monetary inflation (historically 3.25% a year) and wage inflation resulting from gains in real productivity (long-term average of 0.65% annually). And tax brackets are not indexed to account for either of these.

Average incomes rise by an average of 3.9% every single year, and tax brackets stay the same. Which means that every year, more and more people move up into a higher tax bracket (known in economics as “bracket creep”). Or, if you look at it in today’s dollars, what actually happens is that the tax bracket moves relatively lower by 3.9% every year (this is probably on the low end, as recent monetary policy has been expansive, which could easily push inflation to 5% annually or higher which would yield 5.65% annual wage inflation).

Here’s what this looks like represented graphically in today’s dollars:

As you can see, the “millionaire” tax starts off targeting households with $250,000 in combined income or more, but even in a low inflationary environment starts hitting the upper middle class after 10 years. After 25 – 30 years, all but the poorest households are in the “millionaire” tax bracket.

Within 25 years, even if inflation stays under 5%, a married couple earning $29,000 a year each (i.e. combined household income of $58,000) would be in a tax bracket currently being touted as a tax on “millionaires and billionaires.” This is not an accident or oversight on the part of the politicians designing these taxes: their own projections show progressively higher tax revenues each year, not because they think there will be more millionaires but precisely because they know bracket creep will capture more and more of the middle class as inflation pushes them into the higher brackets.

As the economist Frederic Bastiat famously said in 1848: “Government is the great fiction through which everybody endeavors to live at the expense of everybody else.”

But as you sow, so shall you reap.



Leave a Comment
  1. stoneglasgow / Aug 28 2011 9:00 pm

    The strange part about all of this hand-wringing is that the percentage of the wealth Americans produce each year that is confiscated by government never changes very much; it is always right about 18%.

    • Admin / Aug 28 2011 9:20 pm

      Yes, Hauser’s Law. Didn’t want to go into that in this piece, which steers clear of whether tax increases on millionaires is even a good policy idea to begin with, but in such a discussion it’s definitely an important consideration.

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