Tax the rich? Tried before; doesn’t work

Lance McMillian's picture

Suppose you are a conscientious social planner. You are confident in your ability to do good. Alas, you need money to pay for your plans. You decide to meet your need for revenue by raising taxes. But how?

You want to be careful to avoid any tax that negatively affects working class men and women – the very people you want to help. You think hard and come up with the perfect solution: a yacht tax. You decide to enact a 10 percent excise tax on the sale of any boat over $100,000.

You couldn’t design a tax more targeted to capture the rich and only the rich. You congratulate yourself on your wisdom. You eagerly await the tax money that will soon be rolling in.

The problem: your idea has already been tried – and it failed. Big time. Passed in 1990, the yacht tax had an immediate financial impact, but not the one its proponents anticipated. Instead of producing a revenue windfall, the effect was something else entirely: yacht sales cratered.

Who was hurt by this unexpected development? Not “the rich.” Yes, many well-off people had to endure the indignity of life without a sparkling new yacht parked in their boat dock. Big loss. The real victims of the tax – the very people the targeted nature of the tax was designed to spare – were the middle-class workers who build yachts.

In the wake of the tax, the yacht-building industry crashed. Bankruptcies soared. Layoffs – 25,000 of them – commenced. Tax revenues dried up, and the pay-out of unemployment benefits increased.

The perfect tax to painlessly raise revenue had turned into a nightmare and probably cost the government money in the end. It was quickly repealed.

The totality of the failure of this economic experiment crystallized in 1999 when Representative Patrick Kennedy – one of the most liberal members of Congress at the time – introduced legislation called “The Boat Building Investment Act.” Ten years earlier, Patrick’s father, Ted Kennedy, was one of the yacht tax’s most vocal supporters, employing his trademark brand of class warfare rhetoric to urge for its passage.

Times change. The Boat Building Investment Act turned the yacht tax on its head by proposing a tax credit – not even a deduction, but a far more valuable credit – of 20 percent for anyone purchasing an American-made yacht over 50 feet long.

To illustrate, suppose a millionaire otherwise owes $600,000 in federal income taxes. Under this plan, if that millionaire purchased a 50-foot yacht for $3 million during the taxable year, the millionaire would owe $0 in federal income taxes for that year. Talk about a tax cut for the rich.

The younger Kennedy’s rationale for departing from his standard line of soak-the-rich dogma: jobs. Boat-builders in Rhode Island – Patrick’s home state – needed help to save their industry.

When faced with this pressing need of saving the livelihoods of his constituents, Patrick abandoned the economic teachings of his father and instead called a play straight out of the Ronald Reagan fiscal handbook. Kennedy’s calculus: tax cuts equal more jobs.

Today, there is again much talk about taxing the rich to make life better for everyone else. When I hear such talk, I always go back to the lessons of the yacht tax.

Let’s concede that the premise behind the yacht tax has surface appeal. If a person is rich enough to buy a yacht, then that person has money to burn and will not be deterred from a purchase by a 10 percent excise tax.

So this individual buys his yacht, some revenue is raised, and the government re-directs this money to meet a pressing societal need. The social planner has promoted the public good, and no one is worse for wear. On paper, this scenario sounds like the way it should work.

But experience shows otherwise. The rich do not passively accept the fate assigned to them by the taxman. They change their behavior. They move money from tax-disadvantaged areas to climates where the tax treatment is much more friendly.

As these maneuvers play out, it is the inhabitants on the lower end of the economic ladder who bear the harsh consequences of the taxman’s scheme. The result: Increased taxes on the rich invariably hurt the poor and the middle-class more than they hurt the rich. The yacht tax is Exhibit A.

This song-and-dance has played out time and time again throughout history. Still, class warfare remains very much in vogue.

Why? There are cynical reasons, of course. Politicians are expert at pitting groups against one another to increase their own power. That’s not the only explanation, however.

Something else, more fundamental, is also at work. Those who think raising taxes on the rich will solve anything mistakenly see the world as they wish it to be, not as it is.

But reality does not bend to good intentions, and in the world of finance, the reality is this: Money chases opportunity and flees from confiscation. This state of affairs has always been true and will always be true, whether we like it or not.

[Lance McMillian, a Fayette County resident, is a law professor at Atlanta’s John Marshall Law School.]

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