In the first instance, we are treated to the supposition of what society would be like without taxation.
First suppose that we lived in a society without taxation. We'll worry about how the government finances its programs later on, but for now we'll assume that they have enough money to finance all the programs we have today. If there are no taxes, then the government does not earn any income from taxation and citizens do not spend any time worrying about how to evade taxes. If someone has a wage of $10.00 an hour, then they get to keep that $10.00. If such a society were possible, we can see that people would be quite productive as any income they earn, they keep.A most excellent argument in support of anarchy or returning to the hunter-gatherer lifestyle. However, we can immediately see that this isn't true. Are hunter-gatherer societies more productive? Would anarchy give rise to higher productivity?
In the second instance, we are then invited to consider what 100% taxation would look like
Now consider the opposing case. Taxes are now set to be 100% of income. Any cent you earn goes to the government. It may seem that the government would earn a lot of money this way, but that's not likely to happen. If I don't get to keep anything out of what I earn, why would I go to work? I'd rather spend my time reading or playing baseball. In fact, going to work would risk my ability to survive. I'd be much better off spending my time trying to come up with ways to get the things I need without giving them to the government. I'd spend a lot of my time trying to grow food in a hidden garden and bartering with others for the things I need to survive. I wouldn't spend any time working for a company if I didn't get anything from it. Society as a whole would not be very productive if everybody spent a large portion of their time trying to evade taxes. The government would earn very little income from taxation, as very few people would go to work if they did not earn an income from it.Again, we are expected to believe that somehow people would stop working. Nevermind that there wouldn't be things like books or baseball to entertain yourself with, but more importantly, why would a government exist? Doesn't that consist of individuals that also wouldn't make any money?
In short, the example creates an absurdity by claiming that the "government" takes all the revenue, as if it were some independent entity that could somehow exist by itself, and yet wouldn't entail having people operate it. By this example, all individuals would have no income. So, instead of demonstrating that 100% of the income went to the government, it simply indicates that we would have come full circle to a state of anarchy; no government. However, even if we allowed a magical instance of presuming that a government would actually exist that could collect 100% taxes, then where would the means of production exist? Effectively it would mean that the government is not only collecting all the revenue, but most equally provide all the goods and services. Again, no matter how one considers the example, humans must eat, so someone must provide the food, since even the most cynical interpretation would have to allow that the government employees or leaders must minimally eat.
The reality is that taxes are simply another expense that an individual must pay as part of the cost of living in our modern society. Revenue to the government is intended to pay for services, regardless of whether we think those services are worth what we pay, or whether we think they are useful. Those items can certainly be debated, but they are not directly related to the tax rate.
There is fundamentally no difference between paying x dollars to the government for the military or for police/fire than there is in paying x dollars in charges to a credit card company. In both cases, there is an exchange of money in return for goods and services.
Certainly, many people may balk at how those goods and services are provided at the government level, but nevertheless that is the purpose of it. When we pay interest charges on a credit card, we are spending extra money for the privilege of having been advanced credit. It doesn't go for the item that we purchased. It is effectively a "tax" charged by the credit card company to provide that service to us. Again, we may not like the interest rate, but if we use the card, we are compelled to pay for that service. Similarly, if we live in a society, we are compelled to pay our share of what it takes to maintain that society. How that society is maintained is the province of politics; not economics.
As a result, simplistic notions of 0% or 100% tax rates, tell us nothing about the effect of tax rates on productivity. An economy depends on the flow of money, so concentrating money in ANY particular place is problematic. Whether it be individuals or the government. When money stops flowing, the economy stops functioning.
I would expect that almost no one reading this article has ever turned down a job or a promotion because it might increase their tax liability. Neither would one expect that individuals turn down investment opportunities because their taxes might be higher. In short, no one does it, because such a situation is already one that they could engage in.
If you wouldn't work if the tax rate were 100%, then why not exercise that option if the tax rate is 50% or 30% or even 5%? If that is a viable option, then simply move off the grid, become self-sufficient, and don't pay taxes. The point is that you will always work to obtain the necessities and even the luxuries of life. No matter how oppressive an economic policy might be, people cannot simply become ghosts and suddenly consume no resources.
In fact, we have plenty of historical precedence for exactly such an oppressive economic situation. It was called slavery.
So, can tax rates become too onerous? Certainly. Again, we have historical precedence of where individuals in such situations simply move to more favorable societies or governments (2). In no instance have we seen someone simply stop working because the tax rate was too high (3).
In actuality, we see the oppose occur. The more opportunities exist, then regardless of the tax rate, people will apply themselves to earn even more to offset the impact of their tax liability. After all, the more money one makes, even at a constant tax rate, the more income is available to the individual for discretionary use. Food doesn't become more expensive when you have more money. Products aren't more expensive, simply because you have a higher income. So, earning more money is always more beneficial to the individual regardless of the tax rate. This is all the incentive anyone needs to continue working. Only in the instances of where people can't make any head-way do we find them giving up. Even then, they simply become dependent on someone else [i.e. government] providing them the necessary goods to continue living.
So, despite the rhetoric claiming that higher taxes rates will reduce or eliminate jobs, the reality is that no job has ever been created simply because a company or individual has cash on hand. A business must be selling products with an increasing demand, at which point they will look to employee more people to foster growth. Without growth, regardless of how much money an individual holds, they won't hire a single employee. What would be the point?
Even so, the argument goes that with higher tax rates, then companies or individuals will avoid hiring people and therefore it will stifle growth. Yet, this also doesn't make any sense, since investments and expenses are not taxed. Only profits, or returns on investments are taxed, so therefore higher taxes can actually promote investments. Much of the supposed complexity that is alluded to, is irrelevant, since it only relates to specific tax laws. In general, the point is that any action that results in more income to you [from whatever source] is likely subject to some taxation. The rest of the process is simply how one can maneuver around the tax code to protect that money. So, if I invest $10,000 then I will not be taxed on that money until I cash out. At which point it becomes income to me again, and any amount over the original $10,000 would be a capital gains [and there can also be capital losses].
So, what effect is the higher tax rate? That, as well as the debate over capital gains, is when someone chooses to no longer invest, but rather wishes to cash out their investment. Again, we find that the lower tax rate tends to promote individuals cashing out their investments and creating a reluctance to invest, since they get to keep most of their personal income without penalty (4).
In short, with low tax rates, there is no incentive to invest any income to protect it from taxation.
It is important to remember that economics isn't mechanics. There is no equivalent to Newton's laws to accurately predict any particular action or reaction. However, we do have indicators in history that we can use as examples that may provide some insight, and what we find there is that when those with economic means retain it, then they simply become lords over their serfs. Concentrated wealth has never produced freedom nor economic growth (5).
(1) Of interest in this economic post, is that the rationale for lower taxes is to avoid people creating black markets and engaging in illegal tax evasion strategies.
(2) This is an argument often used to explain off-shoring or outsourcing, but that is incorrect. Those actions don't impact the tax liability, they simply reduce expenses by attempting to utilize cheaper labor in lower cost-of-living markets. In fact, if profitability increases, then so does the tax liability, which is another argument indicating that profits are significantly more important than the tax bill.
(3) There is an interesting thought experiment that illustrates that for any tax rate less than 50%, there is still an incentive to work to earn more money. In fact, if there were a 50% tax ceiling, then the incentive is quite high and attractive. Let's assume that for every $100,000 in earnings, the tax rate increases by 10%. So, for $100,000, the tax liability would be $10,000 [10%). Our net would be $90,000, so it's not bad. If we increased this to $200,000, our tax rate would go to 20%, etc. until we got to 50%. At 50% we would be earning $500,000 and half of our earnings would go to taxes. However, this would still be more net income than we earned at any previous level. From this point, if we would retain whatever we earned [even at 50%], then our income could keep growing and while the tax rate would be quite high, our income is also essentially unlimited. After all, from a financial perspective, who wouldn't willingly pay $5 million in taxes, to retain $5 million for personal use? This becomes quite relevant when one considers that the $5 million tax liability could be significantly reduced by investing that money which would stimulate economic activity, as well as providing even more income. It's hard to see a down-side to this situation. [NOTE: Even a loss is, according to U.S. tax laws, something that can be used to offset future tax liability, so even such an event has a positive income impact].
(4) That's not to say that things like the capital gains taxes aren't important considerations, especially for individuals that may be depending on their investments for retirement, but that is a separate issue from the role of investments in job creation and economic growth.
(5) As a simple example, consider who contributes more to the economy. Ten individuals that each purchase a $20,000 car (10 cars) or one individual that purchases a $200,000 car?