A recent proposal by Citizens for Tax Justice to pay for health care proposes limiting the benefits of itemized deductions for high-income workers in addition to imposing an increased Medicare tax on dividends and capital gains. The report claims that these taxes will only hurt the top 1.4% of wage-earners for a whopping sum of $760 billion. Both propositions shrink the worker’s wallet and decrease contributions to charity organizations, while increasing government coffers.
Citizens for Tax Justice offers poor tax policy prescriptions because they fail to understand economic incentives. If legislation imposes an additional $760 billion tax on only 1.4% of Americans, then the taxable base will shrink. The taxable base is reduced because high-income earners have increased economic incentive to avoid taxation.
First, the base decreases in size because wage-earners have higher incentives for tax evasion and tax avoidance. Raising a substantial quantity of taxes from a small fraction of Americans gives those workers an incentive to relocate their earnings to low-tax or tax-free activities. By transferring normally-taxable income these types of ventures, not only is money not being raised for universal health care, it’s not reaching charities either.
Second, higher taxes decrease incentives for production and innovation. Production is maximized when marginal cost equals marginal benefit. If marginal costs increase and marginal benefit remains constant (as they do under increased taxes), then production will fall. Whether we’re talking about physical goods or units of labor, less production means an increase in unemployment.
Organizations like the Center for Tax Justice simply ignore reduced economic incentives for high-wage workers. They assume the high-income individuals don’t have a choice on paying taxes, because they fail to understand that taxation means less production. Real economic analysis takes incentives into account and works to promote positive economic incentives.
Sen. Jim DeMint’s Health Care Freedom Plan understands economic incentives by seeking to work with Americans through tax credits for individuals and families that want to purchase health care outside of their employers’ plan. Any plan for health care reform founded on taxation will lead to negative consequences for