Taxes and Inequality: The Rich, the Middle Class and the Politicians

Back on October 16, 2007, Republican Jim Ogonowski came close to beating Democrat Niki Tsongas in a special election to fill the vacant seat in Massachusetts’s fifth district (a Democratic vacancy, of course, since it was Massachusetts). Ogonowski lost 51% to 45%.

Michael Barone, of U.S. News & World Report, said this about the election:

"This suggests to me that Ogonowski’s two leading substantive issues, taxes and immigration, cut significantly into the Democratic vote in middle-income areas while failing utterly to do so in the high-income suburbs. Perhaps high-income voters, whose accountants do their taxes and who have plenty of money to spend no matter how high taxes are, don’t really mind tax increases, while middle-income voters, who may do their own taxes and have to think hard about how much they can afford to spend on vacations, tuitions, etc., mind more. At least that’s my tentative conclusion."

I would make the comment about taxes slightly differently. Because tax rates stop progressing at about 35%, the amount of additional taxes on each dollar of earned income is not that much more than for some middle class people, especially when both husband and wife work, than it is for higher income people. Also, with capital gains taxes down at 15% (which is good for the economy), to the extent higher income people get more of their income from capital gains than do the middle class, then the overall tax rate on all of their income may actually be less than the overall tax rate for those in the middle class.* If it is not actually higher for the middle class, it will feel like it is higher since they have less.

Barone is spot on, as they say in England, on one point: The high-income people have accountants to do their taxes and figure out all kinds of ways, some legal, others not so, to not pay taxes. When you can do that, taxes may not matter as much. But when you are in the middle class and you cannot, they matter a lot.

This leads to an interesting philosophical question (actually, maybe not so philosophical given what some of the candidates for President are saying): What do you do if it can be shown that a relatively low capital gains tax rate actually helps the economy grow (and helps create more jobs and higher wages), but at the same time the low capital gains tax rate makes people feel upset or mad because of a perceived (though maybe not actual) increase in inequality? What counts: Inaccurate perceptions, possibly/probably fueled by politicians seeking their own advancement, or actual facts?

Tied in with this: If it is important to reduce economic inequality**, do we reduce it by raising the bottom or by cutting the top? And if cutting the top does not really help the bottom (because government wastes the money or spends it so inefficiently), is it still important enough to reduce economic inequality that you can take money away from the top even though you are not raising the bottom? In other words, is it okay to take money from the people at the top, even though that money will not be effectively used to help people at the bottom (or even in the middle), just so the people at the bottom and in the middle feel less unequal?

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* This does not even take into consideration social security taxes, which stop at a little less than $100,000 of income. Social security taxes are a big deal for the middle class, but they are not much more than a speed bump for the rich. (I am not suggesting this be changed. There are good policy reasons for social security taxes to be collected as they are. However, one should realize that they affect the middle class in a different way than they affect higher income people.)

** For a view that it is not important to do so, see Arthur Brooks’ column in the October 22, 2007 Wall Street Journal (subscription required).