The Rich and the Cheap
Could raising taxes or regulatory burdens on the rich have negative side effects? Champions of soak-the-rich policies often minimize the fear of such effects by scoffing: “Pshaw. They can totally afford it.”
Except in the direst circumstances, the champions of taxes and regulation are correct. The rich can totally afford it. While they won’t like further impositions, they have, if need be, plenty of surplus to weather the storm.
What the champions of soak-the-rich policies miss, however, is that the negative side effects of their favorite taxes and regulations can still be horrible. Why? Because the mere fact that a person can afford a burden does not imply that they will, given a choice, ignore the burden. And in the real world, taxes and regulations almost always come with choices.
Don’t want to pay the tax? Earn less.
Don’t want to face the regulation? Do less.
A pedantic point? Hardly. We actually have a word for people who remain highly responsive to prices despite their wealth: cheap. When you tax or regulate the rich, everyone who is both rich and cheap remains likely to change their behavior, leading to standard negative side effects.
How prevalent are people who are both rich and cheap? Common sense says: “Highly. In the long-run, thanks to compound interest, being cheap makes you rich.” The empirics back this up: see the deservedly influential book The Millionaire Next Door. First-hand experience says the same: I, Bryan Caplan, am rich and cheap, like my father before me. Even anti-rich demagogic invective against “misers” agrees — plutocrats can still be penny-pinchers.
The same holds even more strongly for extra taxes and regulations on big business. While large well-capitalized firms are more likely to be capable of paying and complying more, that hardly implies that they will choose to do so. They have another, potentially more profitable option — earn less and do less.
How prevalent are big businesses that remain price-sensitive? Honestly, probably almost all of them. Small businesses may be run by habit or custom, but large corporations have quants to guide them. If extra taxes or regulations render past practices unprofitable, they’re likely to stop — even though they have the cash reserves to continue at a loss.
The upshot: The idea that government can tax and regulate with impunity as long as they focus on rich individuals and big businesses is mostly wishful thinking. The theory of optimal taxation advises governments to target products with low elasticities (or, better yet, negative externalities). But if you follow this advice with an open mind, you’ll utterly fail to reverse engineer a crowd-pleasing progressive regime. Instead, the you’ll start with big regressive taxes (or “fees” if you prefer) on pollution and congestion. If and when you exhaust those convenient opportunities, your next best revenue sources will be “necessities” (products with low demand elasticity) and “natural resources” (products with low supply elasticity). Gochenour and Caplan (2013) notwithstanding, that probably means a Georgist tax on unimproved land value. Which, due to widespread home ownership and the low income-elasticity of housing demand, mostly burdens the middle class rather than the rich.
Yes, this is an important point. Here's an example of counterproductive policy:
I was running the numbers on an $800k inherited IRA and the incentives and consequences generated by the government's requirement that it be cashed out and taxed over the next eight years (instead of over my remaining life).
If I continue working, the government will take more than 40 cents on the dollar from the disbursements of this IRA, a total of $320k; on the other hand, if I retire early instead, the tax bill will be 20 cents on the dollar as my taxable income will be much lower and I'll get to keep an additional $20k/year. The difference is enough to pay for healthcare off the exchange for the eight years of my early retirement until Medicare kicks in. That's a substantial incentive to retire early.
And if I do so, the substantial drop in my taxable income leads to reduced federal, state, and local tax collections from me in excess of $100k per year, or a total of $800k+.
High taxes on people with low marginal propensity to consume reduce savings and investment even when they don't change behavior: Simply by virtue of paying a lot in taxes, they have less money left to save and invest.
This is why things like taxes on wealth or unrealized asset appreciation are especially destructive: They're heavily skewed towards people with low MPC, and thus result in a greater reduction in investment per dollar of revenue raised than taxes on consumption or even income.