Thursday, November 25, 2010

What is rich -an interesting perspective and food for thought

Go Ahead, Tax the Rich, Just as Long as It's Not Me
Cliff Ennico
A lot of people are confused right now about Congress' plans to raise taxes (more precisely, eliminate the Bush-era tax cuts) for people with incomes of $250,000 per year or more.

"How can anyone argue against a tax increase for rich people?" I've heard people ask. "After all, they can afford it more than middle-class people can. And raising these taxes will generate $700 billion in revenue for the government over the next 10 years without anyone suffering too badly."

There's nothing wrong with that logic. Since 1913, the federal government has been committed to a program of "progressive" taxation -- basically, the more you make, the more taxes you pay. Aside from affordability, many people believe that wealthier people have a social obligation to subsidize government benefits for those who are less well off (and besides, there are so few rich people that their votes at election time don't count for much).

The problem comes about in defining precisely who is "rich" and who isn't. There's an old saying: "A rich person is anyone who makes more than I do." In other words, it's OK to increase taxes on the rich as long as I myself am not included in the definition of "rich."

I have always had a problem with a progressive tax system that is based solely on people's income. The reason is that I have always lived in the New York City metropolitan area, where the cost of living is extremely high. A lot of people I know make more than $250,000 a year, and they are outraged by the notion that they are so rich that they can afford a significant tax hike.

To understand the shortcomings of a progressive tax system based solely on income, take the following two situations:

-- Person A lives in rural Kansas, in a sprawling family farmhouse with no mortgage. Person A has an annual pretax income of $150,000, has no dependents and has average annual expenses of $30,000.

-- Person B lives in midtown Manhattan, in a cramped two-bedroom condo with two mortgages and two children in private schools (not because Person B is a snob, but because his kids stand a better chance of surviving to adulthood than if they were in New York City's public schools). Person B has an annual pretax income of $300,000 and has average annual expenses of $270,000.

Who would you say is the "richer" of the two? Most of us would say Person A, and we would be right from an economic point of view. Person A makes half as much as Person B, but has four times the discretionary income of Person B ($120,000 versus $30,000) because of Person A's low expenses.

However, under our current tax system, Person B is considered to be "richer" than Person A, and is taxed at a higher rate. If the Bush-era tax cuts for high-income people are not extended, Person B will see a significant increase in his taxes. The tax increase for Person B may be enough to wipe out his meager discretionary income and may threaten his personal liquidity. Meanwhile, Person A, who could more easily afford a tax increase because of his high annual discretionary income, continues to enjoy a "windfall" from his continued low tax rate.

The big assumption here, of course, is that all of Person B's expenses are necessary and unavoidable, and not the result of irresponsible luxury spending. In my example, I think they would be -- New York City has the highest cost of living, real estate costs, and state and local taxes of just about anyplace in America. And anyone who knows anything about New York City's public schools would send their kids to private schools in a heartbeat if they lived there. Frankly, there isn't much room for Person B to cut back on his living expenses.

There isn't any effective way for the government to base taxes on "discretionary income" -- this varies widely from individual to individual, and somebody's "necessary" expense is somebody else's "luxury." ("After all," I can hear some readers thinking, "nobody's forcing Person B to live in Manhattan" -- except perhaps his employer).

But if the government's goal is to allocate tax burdens to those best able to bear them, I think a better approach would be to base our tax system upon people's assets -- what they're worth after taking expenses into account -- rather than just their income. With a tax on individual net worth (or perhaps a progressive income tax that is adjusted or "weighted" to reflect a person's overall assets), Person A would pay higher taxes than Person B, resulting in a much more fair and equitable outcome.

If as a business owner you make a significant income but are working 24/7 in your business and are up to your ears in legitimate business debts, you are not "rich," yet the government thinks you are. It's time for that mentality to change.

Cliff Ennico ( is a syndicated columnist, author and former host of the PBS television series "Money Hunt."


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