Unlike most of the super-rich, billionaire Warren E. Buffett is once again  advocating for higher taxes on the wealthiest Americans. His basic argument: High taxes on the wealthy have not historically hindered the economy—a counterargument to those who believe we should always lower taxes for “job creators.” While I understand and appreciate Mr. Buffett’s argument, it also embodies a more pragmatic view of fiscal policy: American entrepreneurs will continue to pay taxes regardless of the tax rate on higher revenues. This is largely due to basic Internal Revenue Service rules concerning who is required to pay taxes to the U.S. government.
This simple fact offers the basis for a post-Bush fiscal policy focused on higher taxes for higher earners. My aim here is not to make a political argument. Rather, I wish to show the rationale underlying the position of most Democrats and an increasing number of Republicans.
Other countries are addressing the question of increasing taxes on the wealthiest with varying degrees of success. After French President François Hollande announced higher taxes on upper-middle and upper-class income earners, Bernard Arnault—head of the Luxury consortium Louis Vuitton Moët Hennessy—declared “en fanfare” that he was moving to Belgium (and applying for Belgian citizenship). Under French law, this would mean that Mr. Arnault would be free from the French tax code, and obligated only to pay taxes in Belgium, not in France.
I cannot imagine Bill Gates or hedge fund mogul John Paulson moving to Canada or the Cayman Islands next January if Congress passes a plan to collect higher taxes from the wealthiest Americans. The French may be “proud of their citizenship” (to quote President Hollande’s reaction to Mr. Arnault’s announcement), but Mr. Gates’ foundation is headquartered in Seattle, and Mr. Paulson recently signaled his attachment to New York City by giving $100 million to Central Park’s Conservancy.
More crucially, the I.R.S. tax code states that all citizens and permanent residents are required to file federal taxes. For citizens, this is true regardless of their residence or the location of their assets. Many of the wealthiest Americans got in trouble some years ago for not disclosing monies held in Switzerland. In the hypothetical scenarios of Bill Gates and John Paulson, both would still be under obligation to file federal taxes in the United States, and most likely pay taxes to the U.S. government, even if they lived abroad. Americans could not simply apply for citizenship in another country to be tax free in the United States; they would also have to renounce U.S. citizenship, potentially creating a public uproar unimaginably larger than the French’s reaction to Mr. Arnault’s move.
Taxes and Revenues
There are two basic ways to increase revenue. Either one increases the number of payers (increasing the tax base), or one increases the average amount collected from each payer. Either of these levers can be activated in various ways. Increasing the number of payers requires moving people move from unemployment to employment. So increasing average tax revenues means either boosting the economy in order to increase average taxable income (and/or reducing exemptions and deductions), or increasing tax rates. Economically, the easiest of these options is the last one, mostly because the first depends on the health of the economy, something that itself is dependent on a large number of variables.
What Mr. Buffett hinted at in his Nov. 25 op-ed in The New York Times, “A Minimum Tax for the Wealthy,” and what is learned from the U.S. tax code, is that the number of taxpayers, especially among the wealthiest citizens, is unlikely to decrease even as tax rates increase. Therefore, in terms of public finance, increasing rates is the surest way to increase tax revenues, and to work toward closing the annual fiscal deficit. Targeting a tax increase on the wealthiest Americans gets us into questions of justice, fairness and the marginal utility of money (a $20 bill means a whole lot more to a single mother in Queens than it does to Manhattan-ite John Paulson). Fairness is a different topic from the pragmatic stance I am adopting in this essay, and certainly a more politically loaded one. But there is a good reason why some Republicans are joining their Democratic counterparts in supporting an increased tax rate for the wealthiest Americans: It is a direct path away from the so-called “fiscal cliff.”
Grover Norquist has been the most prominent supporter of the Republicans’ strict “anti-tax” stance. Yet Mr. Norquist does not seem to understand finance, let alone public finance, very well. In a recent interview on NPR, Mr. Norquist was asked which of the following was most important: increasing taxes, reducing the national debt or lowering spending. He argued that reducing spending was the most important, since other two were equivalent. In his mind, funding $100 of spending by taxes or by increasing the debt is the same thing, so the focus should really be on the main variable, namely spending. Yet funding by debt is always more costly than funding by taxes. This is because the government has to pay interest on its debt, while collecting more taxes, as we have seen, does not cost more money than collecting less (I.R.S. employees are paid the same regardless of the amount of taxes collected). Sure, Dr. Arthur Laffer’s theory that as tax rates increase, people may work less hard, collect less money and thus pay less in taxes holds some credibility. But especially for the highest earners in our country, this does not seem to hold true in our economy. Billionaires still want to earn as much money as possible. They play a rich man’s version of monopoly: It’s not pure efficiency that counts; it’s showing how much one can make.
Mr. Norquist’s insistence on the primacy of spending cuts does not hold, and thus the entire equation must be re-evaluated. It is essential for the U.S. government to show better fiscal numbers in the future, including the near future. The goal of avoiding the “fiscal cliff” does not have one simple answer, be it less spending or more taxes. The president, Congress and the many economic advisors involved must all look to compromise. Political remembrance is tricky. President Reagan is remembered as a fiscal conservative, but his emphasis on military spending triggered the trend of massive (and growing) American debt. President Clinton, a Democrat who promoted universal health care, was in office during an overall economic boom, and the federal deficit became a surplus. Under President George W. Bush—strong promoter of fiscal conservativism on face value—America became involved in costly wars that engulfed a large part of the federal budget. Partisanship does not apply here. Nor do presidents or legislators actually have much control over the state of the economy in the short run, though it is precisely the economy as a whole that controls much of our destiny in relation to tax revenue and the federal deficit. It is encouraging to see Republican legislators stepping away from Mr. Norquist’s ill-conceived pledge. It is troubling to see Democrats boasting over the recent election results by refusing to cut spending on the costliest government programs. Politicians on both sides of the aisle, and Americans of all stripes, must take the challenge of the so-called “fiscal cliff” as an opportunity for common humility rather than individual hubris. December 2012 is not a chance to display political strength. Rather, it is a call to take the challenges of 21st-century America seriously.
Our problems are quite serious indeed. Too much of our present and our future is already out our hands, mortgaged by previous leaders or held by foreign powers. The weeks to come will show our political maturity or our abysmal lack of financial understanding. Our global economy makes our current situation a unique one: Never has a world leader been so financially dependent on the rest of the world. After World War II England recovered slowly from four straining years of war. In 1989 the Soviet Union collapsed after decades of ill-conceived experiments in resource allocation. What will happen to the United States after 30 or 50 years of massive national debt? It would be a shame to let history unfold while passively standing on the sidelines—out of political arrogance or a loyalty to ill-conceived pledges.