Economics Lesson: Taxing “High-Income” Earners Means Taxing Small Business

By SBE Council at 19 August, 2022, 10:24 am

by Raymond J. Keating –

As part of a poll done in July, Gallup asked Americans what they thought about taxes on high-income earners. There are some lessons to takeaway Gallup’s presentation regarding their findings, as well as the need to think more clearly in economic terms.

Gallup asked the following question:

“People feel differently about how far a government should go. Here is a phrase which some people believe in and some don’t. Do you think our government should or should not redistribute wealth by heavy taxes on the rich?”

As with many polling questions, there’s a matter of differing definitions regarding terms. In particular, what does “heavy taxes on the rich” mean? Some people believe that the rich already are being taxed heavily, and others don’t.

As for the answers, Gallup reported that 52% agreed that government should redistribute wealth by heavily taxing “the rich,” while 47% disagreed.

Gallup has asked this question several times going back to 2007, with the answers fluctuating. But throughout, the results have been very tight, with agreement running just ahead of disagreement since 2013.

Interestingly, the analysis offered by Gallup featured the following statement, referencing the Inflation Reduction Act:

“The average American, on the other hand, would not have minded if the law had increased taxes on the rich. Americans tend to be more likely than not to favor higher taxes on those with high incomes. This fact of life has been well-established across a wide variety of public opinion indicators over the years.”

Hmmm. Really?

Margins of Error and Gallup’s Bias

What’s perplexing for a polling company is to ignore its poll’s margin of error. In this case, the margin of error was +/- 4 percentage points. What does that mean? Well, each result has an error range of +/- 4 points. Therefore, those agreeing that government should impose heavy taxes could be as high as 56% or as low as 48% (again, +/- 4 points) and those disagreeing with heavy taxes on upper-income earners could be as low as 43% or as high at 51%.

Therefore, bold declarations based on a poll requires that the results lie outside the combined, if you will, margin of error. In this case, the total spread between the two results needs to be larger than 8 points. That most certainly is not the case here.

So, the above declarative statement from the Gallup analysis really doesn’t hold up, nor do various others remarks.

Interestingly, Gallup noted that a poll was done on this question way back in March 1939, and at that time, with the Great Depression still laboring on, the results came in with 54% disagreeing with imposing heavy taxes on the rich versus 35% agreeing with heavy taxes. That was a spread of 19 points.

So, what’s happened over the past 80-plus years?

Polling and Economic Knowledge

Here we turn away from polling and to economics. The recent statistical dead heats on this question point to a lack of understanding in terms of the effects of heavily taxing upper-income earners.

Here’s how I summed up the role that wealthy individuals play in the economy, and therefore, why taxing them heavily makes no economic sense, in my book The Weekly Economist: 52 Quick Reads to Help You Think Like an Economist:

It’s time to discuss why the wealthy, or rich people, rock when it comes to the economy. This, of course, goes against much of our politics, especially given the big role that class warfare plays in our discussions regarding taxes, and whenever the boogey man of economic inequality is brought up.

So, let’s put aside politics, and deal with actual economics when it comes to the wealthy and the role they play in our economy.

First, in a free market system, only one way exists to earn considerable wealth, and that’s by supplying goods or services that other people want or need. No matter what the internal motivations might be of any individual, the free enterprise system requires a person to look to others first in order to achieve success. That’s certainly not the case with socialism or the welfare state. So, in a capitalist economy, rich people get rich by creating value for others.

Second, rich people have the wherewithal to supply the financial capital that entrepreneurs need to grow new businesses, thereby driving economic and job growth. If one wants to grow a business, you have to go to angel investors or venture capitalists, depending on the point of development in the business, to get the necessary funding. Entrepreneurs need to go to rich people who have the resources to invest. So, just as labor and business owners need each other to make a business function and succeed, they also need individuals with the ability and willingness to lend and invest. That is, they need rich people.

Third, even if rich people don’t invest, but instead decide to spend the wealth they have earned, such spending still has value to others. For example, consider that the big tax increase of 1990 included a luxury tax, including on yachts. Who was hurt by this tax? Well, those buying yachts ventured into international waters to do so. So, the U.S. boat building industry was hit with lost business and big layoffs. Tax the rich, and hurt those who are not rich.

So, why, then, go down the path of class warfare or soaking the rich? The answer is a combination of zero-sum thinking, a love of government, and/or the sin of envy. It’s certainly not about clear economic thinking. Economics tells us that rich people rock.

Taxing “the Wealthy” Means Taxing Entrepreneurs and Small Business

Oh, yes, it also must be noted that a solid majority of upper-income earners turn out to be entrepreneurs themselves, that is, owners and operators of their own businesses. Consider what CNBC reported earlier this year: “The 1% [in total wealth] own 57% of private companies, according to the Federal Reserve.”

CNBC quoted Edward Wolff, professor of economics at New York University, pointing out the following about the wealthiest: “Small business is really key when you talk about the sources of their wealth.”

Yes, taxing the wealthy means taxing small business.

People need to stop listening to political diatribes against wealth and the wealthy, and get back to a basic understanding of economics, including the economics of taxation, in particular, that heavy taxes on the wealthy mean less resources for investing in the entrepreneurial ventures that drive economic, productivity, income and employment growth.

Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council. His latest book is The Weekly Economist: 52 Quick Reads to Help You Think Like an Economist.