Economic Growth and Tax Law Correlations

Author's Note: This is the third in a four-part series on wealth and income inequality.

"Tax the rich...feed the poor...
‘Til there are no rich no more?"
— "I'd Love to Change the World"
as performed by Ten Years After

Should we soak the rich to solve wealth and income inequality? 

European nations attempted to and found their tax policies ineffective. Seeking more friendly tax havens, many of their wealthier citizens simply moved their businesses and residences abroad. Levying a wealth tax on Americans would likely produce similar results. In an era when the U.S. is struggling to keep businesses operating here at home, tax law changes which drive them elsewhere will likely prove counterproductive to our national economic goals.

Still, soak the rich proposals abound. Last week we reviewed Senator Huey Long's “Share The Wealth” program, proposed in 1934. We are currently seeing more wealth tax proposals than at any time since the Great Depression.

Currently, income tax rates top out at 37%. Capital gains taxes are imposed on profits generated through investments and max out at 23.8% for higher-income folks. 

Historical evidence is scarce as we only have about a 100-year contiguous window to study how various income tax rates impact economic growth. So it’s difficult to look back in time and definitively prove that higher or lower tax rates helped or hurt broad economic growth. Although periods like the 1960’s featured high tax rates on the wealthy and strong economic growth, the two don’t necessarily go hand in hand. And there are some significant cautionary signals for raising taxes on the wealthy. 

Back then our rich citizens were more often becoming wealthy through earned income rather than through financial investments. Today, many of the wealthiest Americans earn their money through investments or leveraged financial transactions which are often only subject to the lower capital gains rates. Additionally, capital is much more mobile than it was back then, which makes tax avoidance easier.

Still, many of the 1% are becoming wealthy through small business enterprises, and indeed pay taxes on earned income. Should we really institute a progressive tax of 70% on income over a certain threshold? Should we charge a 2% tax on wealth over $10 million?

These questions are at the heart of the current wealth inequality debate. We must address this issue, but it should be tackled from the bottom up, not from the top down. Soaking the rich with oppressive tax rates will drive business away and cause entrepreneurs to seek foreign tax havens. 

Next week we’ll wrap up our four part series with tax proposals that would address wealth inequality in a way that would create opportunity for more Americans while avoiding the pitfalls of past taxation policies.

Margaret R. McDowell, ChFC®, AIF®, author of the syndicated economic column “Arbor Outlook,” is the founder of Arbor Wealth Management, LLC, (850.608.6121 – www.arborwealth.net), a fiduciary investment advisory firm located near Sandestin.This column should not be considered personalized investment advice and provides no assurance that any specific strategy or investment will be suitable or profitable for an investor.