The Columns

Saying something doesn't make it so

— by on November 28th, 2011

The following piece by Washington and Lee University finance professor Scott Hoover appeared in the Nov. 27, 2011, editions of the Richmond Times-Dispatch and is reprinted here with permission.

By Scott Hoover

Facts are stubborn things; and whatever may be our wishes, our inclinations, or the dictates of our passions, they cannot alter the state of facts and evidence.

–John Adams

Listen to some pundits and you hear that conservatives are rabid protectors of the rich while liberals are staunch defenders of the poor. Listen to others and you hear that liberals fight to kill the American dream in favor of a socialist society while conservatives preserve incentives for people to be inventive and entrepreneurial. This is clearly shown in the tax debate, a longtime political battlefield that has recently been fueled by various budget proposals. We can endlessly discuss whether the current tax system is fair, but what ultimately matters is whether higher taxes on the rich would make a difference.

The IRS provides useful data on individual income taxes. For example, in 2009 (the most recent data year), the 723,000 households earning more than $500,000 per year raked in $900 billion dollars of taxable income. Sounds like a lot, but it is not. To understand this, let’s pretend a bit. Let’s pretend that our political leaders agree on a balanced budget that applies to each year now and forever. Let’s pretend that they also increase the tax rate on rich households to 100 percent yet these rich people maintain the same level of productivity. What would that do for the economy?

Those rich households currently pay an average income tax of 29 percent, leaving them with about $640 billion dollars after federal taxes. A portion of that goes to state taxes and other fees, so let’s pretend that there is $600 million left to play with, all of which is collected by the government under the new 100 percent tax law. How long would it take to pay off the national debt? Not one year or two or three, but 25 years.

Note that our national debt has grown by more than a trillion dollars each year recently. Implication? A 100 percent tax on the rich would not even offset the annual deficit. The national debt would never be retired. It’s that simple. Note also that that one recent proposal is for a 5 percent surcharge on the rich, a mere fraction of the 100 percent rate in our pretend world. The reality? The rich make a lot of money relative to most of us, but they don’t make enough to make much of a difference in the big picture. The fate of America rises and falls on the backs of the middle class. Solutions must start there.

Most find it difficult to argue against raising taxes on the rich. After all, we tend to be jealous of the rich and wish, albeit secretly, to somehow bring them down to our level. Greed is a sin, but so too is envy. This is the same sort of envy that causes us to root against teams like the New York Yankees. We justify our demands for higher taxes on the rich by saying that higher taxes would be fairer, yet we offer no definition or assessment of what “fair” means. We claim that our tax laws favor the rich, but we fail to show that higher taxes will actually solve our problems. Unfortunately, saying that higher taxes are fairer and would solve our problems does not make it so.

Legend has it that a man asked Abraham Lincoln for some appropriation, citing questionable facts to support his request. In denying the request, Lincoln asked, “How many legs does a dog have if you call its tail a leg?” “Five,” the man replied, to which Lincoln answered, “No, four. Calling a tail a leg does not make it one.”

Is it too much to ask that we stop pretending that taxing the rich will solve our debt and deficit problems?

Scott Hoover is an associate professor of finance at Washington and Lee University. He is the author of How to Get a Job on Wall Street: Proven Ways to Land a High-Paying, High-Power Job and Stock Valuation: An Essential Guide to Wall Street’s Most Popular Valuation Models. Contact him at hoovers@wlu.edu.