Breaking All the Rules …

There was a lot of coverage of President Obama’s state of the union address here, and I want to comment on part of it because a lot of the ideas that those who lean left come up with there end up coming up here as well.

What was most ironic about the speech was that in one breath Obama was saying that he wanted everyone to follow the same rules and then in the next breath he was saying that the rules should be different for different people — but it’s only for those who are rich, so that’s okay. The different rules came from his talk about saying that anyone who earns 1 million dollars or more should have a 30% tax rate, which is in response to comments from people like Warren Buffet that the rich don’t pay enough, as people like Buffet and Mitt Romney have revealed that they have a lower tax rate — but not, you’ll note, a lower absolute amount of tax — than their secretaries at times. Obama and others are going to town on this being unfair and something needing to be done to fix it. The problem is that they are comparing apples and oranges, because the problem isn’t what you make — it’s not the case that making over 1 million dollars will automatically give you a lower tax rate (quite the opposite) — but it’s that those who have the lower tax rate are earning their income in different ways than those who are earning it more “normally”.

So, in order to see how this is treating people by different rules, consider these two cases. Person A makes 1 million dollars a year using certain methods. Person B makes 100,000 dollars a year using the precise same methods. Presumably — although in the real world things never work out this evenly — because the tax rate is a ratio they both would pay the same ratio of tax, which is 14%. Now, let’s take Person C, who earns 1 million dollars the same way Buffet’s secretary does. Presumably, again, that person would pay the same rate as the secretary. The rules and rates, then, change on the basis of how you earn your income, not on how much of it you earn (mostly, since most countries do have progressive tax rates where people who earn more do pay a higher rate, but we can ignore that for now).

So now we introduce Obama’s fair plan. Now, A pays 30%, but B still pays 14%. But other than the amount they make, there’s no difference between them. Which is unlike the case we have now, where how you earn the money is what matters.

So you can argue that maybe how the money is earned shouldn’t matter. Maybe it shouldn’t. But if certain forms of income are taxed less, in general it’s because the government wants to encourage people to earn their money that way. So, for example, investment income in both Canada and the U.S. is in some sense exempt from taxes, or at least part of it is. More of it is exempt in the U.S. than in Canada, I’m told. Investment is risky, but can have big payoffs, and it helps to keep companies going and the stock market going as well. So, you have to think about why some forms of income are taxed less and see if you still want people trying to earn their income that way. Because if riskier forms of earning income are not encouraged, a lot of people won’t use them (that was indeed the point), and that would be bad.

And let’s hope that these calculations are based on income after deductions, because that’s a whole other mess if it isn’t.

The point is that saying “Everyone who makes over 1 million dollars pays 30%” is a nice, simple thing to say that everyone can understand. But it may not be a good thing to do. It may cause massive problems and actually end up hurting the middle class more than helping by chilling investment, research and development, and job creation. There’s no simple way to untangle this if you want to preserve what the actual tax laws are supposed to do. But I suspect that Obama knows this, and suspect that he never would actually implement this. He may try before the election knowing that the Republicans will stop him, but he’d never try it if it went through because it’s just a bad idea. It sounds nice, but won’t work.

Up here, the Liberals might talk about it but would never implement it. The Conservatives won’t talk about it. The NDP might actually try to implement it, which is one of the reasons having them actually running the country is scary.

Anyway, if there is a problem with these tax breaks being used by people or by people with incomes for what it was not intended and in a way that’s actually harmful, then you need to tighten up the laws. This suggestion, however, is not fair, not just and generally not a good idea.

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