Poor returns from soaking the rich

Two men walk down the street from the King and Bay intersection in the financial district in...

Two men walk down the street from the King and Bay intersection in the financial district in Toronto February 22, 2011. (REUTERS/Mark Blinch)

Michel Kelly-Gagnon, QMI Agency

, Last Updated: 4:36 PM ET

A much-discussed paper written last fall by economists Peter Diamond and Emmanuel Saez suggested, as one of its central propositions, to raise the tax rate of top earners in the U.S. as high as 70% - double the current marginal rate.

That would be, according to the authors, the upper limit of an "optimal" tax rate - one that would maximize revenues collected by the government from these top earners.

The argument goes as follows: a marginal dollar of income makes very little difference to the welfare and happiness of the wealthy (those earning $400,000 or more), while it does for the rest of us. So it makes sense, from a policy perspective, to raise as much money as possible from the rich. Or so the argument goes.

This study gets new impetus in The Occupy Handbook, a new book edited by Janet Byrne and filled with essays by various economists, journalists and other public figures. It's a compendium likely to add fuel to the tax-the-rich rhetoric that is popular in many journalistic and intellectual circles.

But this book, to the credit of their editors, also contains a few articles that present counter-arguments.

First, common sense tells us that such a substantial tax hike will trigger changes in the behaviour of those high-income earners. For instance, the rich might reduce the amount of tax they pay, either by working less, moving their earnings underground, or using legal means to reduce their taxable income. After all, as economist Stephen Williamson puts it on his blog, why would an entrepreneur want to undertake a costly and risky investment for a very big payoff with very low probability, if that big payoff will then be taxed at a 70% rate? Taxing the rich, at least at that level, destroys incentives and punishes success. That's why such tax schemes end up raising much less money than anticipated.

Great Britain is a case in point. The British government raised, in 2010-11 fiscal year, the higher marginal tax rate on the country's top 1% of income earners from 40% to 50%. The higher rate was expected to add £3 billion ($4.7 billion) to the government's treasury. That proved to be wishful thinking. According to the most recent estimates, the British treasury barely broke even with that reform.

Another contrarian bit of information in the The Occupy Handbook, offered by Tyler Cowen of George Mason University, and Veronique de Rugy of the Mercatus Center, is the notion that the United States is already a far more fiscally progressive country than we think.

According to these scholars, data from the Organization for Economic Co-operation and Development shows that the top 10% of households in the United States currently pay 45% of all income taxes in the country (personal income and payroll taxes combined). Meanwhile, the average tax burden for the top 10% of households in OECD countries is 31.6% of the revenue intake - well below the contribution that rich Americans make.

In other words, rich Americans already pay more than their fair share, no matter what Warren Buffett says.

- Michel Kelly-Gagnon is president of the Montreal Economic Institute (www.iedm.org). The views reflected in this column are his own.