Higher Marginal Tax Rates Won’t Improve the World

June 11, 2014

The New York Times’ The Upshot uses Dave Chappelle’s recent appearance on the “Late Show with David Letterman” as an opportunity to discuss the need for high top marginal tax rates.

From The Upshot:

"'So I look at it like this,” Mr. Chappelle said. “I’m at a restaurant with my wife. It’s a nice restaurant. We’re eating dinner. I look across the room and I say: ‘You see this guy, over here across the room? He has $100 million. And we’re eating the same entree. So, O.K., fine, I don’t have the $50 million or whatever it was, but say I have $10 million in the bank.’ The difference in lifestyle is minuscule.'

That’s a reason advocates of higher marginal income tax rates on the highest earners would argue there is little loss of human welfare by enacting very high rates on the highest income brackets. The difference in quality of life between “very wealthy” and “extraordinary wealthy” is not that great, which should make it a relatively painless way to raise tax revenue."

The Upshot and Dave Chappelle, while possibly correct in his illustration of diminishing marginal utility of wealth, miss the point. It’s not about the streaks that wealthy people buy and it’s not entirely about the incentives to make more money; it’s about the alternative uses of money.

In a world with high marginal tax rates, the government collects additional money from Dave Chappelle and his restaurant companion and put it to its own purposes, whether that is a government housing program or national defense. The question is: what is the alternative?

When a government levies high marginal tax rates, the man worth $100 million has less money in his own pocket. Instead, if the government didn’t levy the tax, what does the man do with the money? Sure, maybe he buys a couple Ferraris or goes out to a lot of nice dinners or rents the most expensive penthouse in New York City.

But as Dave Chappelle points out for us, that’s not what he does. “The difference in lifestyle is minuscule,” he said.

So what do Dave Chappelle and the $100 million man do with their money?

In the worst case scenario, they take the money and put it in a savings account. But despite popular belief, that money doesn’t just sit there. The bank takes that money and it lends it to a person who wants to start a business or a couple who want to buy their first house.

Think of the scene from It’s a Wonderful Life when everyone crowds into George Bailey’s building and loan office to retrieve their money during the run on the bank:

“You're thinking of this place all wrong. As if I had the money back in a safe. The money's not here. Your money's in Joe's house...right next to yours. And in the Kennedy house, and Mrs. Macklin's house, and a hundred others. Why, you're lending them the money to build, and then, they're going to pay it back to you as best they can.”

Money not taxed and simply saved still contributes to a productive society. But there are even better cases than the man with $100 million putting his money in the bank. And they are even more likely to happen.

Instead of opening a savings account, let’s say the man with $100 million dollars invests his money in a company, say through the stock market. The company then uses that money to build a new factory and fill it with machines that build computers. That investment has the potential to not only provide work for hundreds of people, but also make it so more people are able to buy computers so they can call explore the world through the internet or correspond with their grandkids away at college.

Money allows us to do things. It allows us to investment in tools that make life easier and make life better. When we let money be, it can do good things--it can help people live fulfilling lives. It can help us build computers and phones and houses and cars.

The Upshot and Dave Chappelle may be right that for someone with a $100 million that next dollar might not means as much as the first dollar. But that money doesn’t sit collecting dust. It is invested in the broader economy.  It is “in Joe's house...right next to yours. And in the Kennedy house, and Mrs. Macklin's house, and a hundred others.”

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