Fred Thompson Talks Tax Incidence

In his speech last night at the Republican National Convention, fromer Tennessee Senator Fred Thompson actually brought up the issue of tax incidence, albeit in a non-academic political soundbite. From the LA Times:

Now, our opponents tell us not to worry about their tax increases. They tell you they’re not going to tax your family. (Laughter.) No, they’re just going to tax “businesses.” So, unless you buy something from a business, like groceries or clothes or gasoline — (laughter) — or unless you get a paycheck from a business, a big business or a small business, don’t worry, it’s not going to affect you! (Laughter, cheers, applause.) They say they’re not going to take any water out of your side of the bucket, just the other side of the bucket! (Laughter.) That’s their idea of tax reform.

While candidate Obama hasn’t explicitly said he would raises taxes on business (besides oil companies), let’s assume that Thompson is correct in his initial assumption that Democrats would raise taxes on business. (Obama would raise taxes on some businesses that file under the individual tax system.) Would such tax increases take water out of a bucket? The answer is yes, but while such an analogy may sound good, the fact of the matter is that not everybody is in the same exact bucket. While their buckets may be loosely connected, Bill Gates is not in the same bucket as Joe Blow.

Sticking with the buckets theme, Obama’s tax plan is more like this. Obama takes a glass and dips it into the rich person’s bucket. In the process of trying to transfer it over to the poor person, some drips onto the floor. (Deadweight loss: Some income that was once there is no longer there to be taxed. How much, we don’t exactly know, but some would be lost.) The amount that didn’t fall onto the floor would go into the poor person’s bucket (redistribution).

The poor would be hurt indirectly by the rich person’s tax burden through slightly lower wages and slightly higher prices (some of what was in his bucket would evaporate), but the dollar amount of redistribution from rich to poor would likely outweigh any adverse harm imposed on the poor from the rich’s tax hike.

(This also ignores the fact that the rich may benefit to some degree from greater mandatory redistribution…if redistribution to the poor is a public good.)