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Taxes on Millionaires Make Great Politics, Poor Economics

In this age of austerity, many governments are looking for ways to fill gaps in their budgets by taxing the rich more. These proposals make for great politics, but terrible economics.

This week, the U.K.’s coalition government will produce its budget for the next year. Among proposals being discussed between the coalition partners is a so-called mansion tax -- an annual 1 percent levy on homes worth more than 2 million pounds ($3.2 million).

In Russia, meanwhile, President-elect Vladimir Putin has put forward a luxury tax to be levied on purchasers of high- end cars and real estate. In France, the Socialist Party’s presidential candidate, Francois Hollande, is proposing a 75 percent tax rate on earnings above 1 million euros ($1.3 million). His conservative opponent, President Nicolas Sarkozy, has parried with proposals to tax the worldwide revenue of large French corporations and to collect taxes from fiscal exiles.

Hollande’s plan may in turn have been inspired by the debate in the U.S., where President Barack Obama has proposed a surtax on Americans with incomes of more than $1 million. The plan is known as the Buffett Rule, after Warren Buffett, who argued for higher taxes on billionaires like himself.

Buffett should surely not pay a lower tax rate than his employees. But few of these proposals would make a dent in the budget deficits facing the countries involved. Buffett’s own effective tax rate is lowered by the large proportion of his income that comes from dividends and capital gains, which incur lower tax rates than regular earnings. It isn’t clear a surtax on the rich would change that.

Take the mansion tax idea in the U.K., which Prime Minister David Cameron has been trying to get his Liberal Democrat coalition partners to drop. The tax would raise about 1.7 billion pounds annually, according to a Liberal Democrat estimate, which the Institute for Fiscal Studies, a nonpartisan think tank in London, says is about right. That would barely scratch the budget deficit, which the institute projects to be 124 billion pounds over the next year.

The French Socialist party has estimated that its planned millionaires’ tax would raise 200 million to 400 million euros, an insignificant figure. And analysts say revenue from the tax might well prove lower still, depending on how France’s superrich respond.

As for the Buffett Rule in the U.S., the billionaire investor’s “Je m’accuse” was laudable, but it also switched debate from whether to raise taxes on the top 1 percent of U.S. income earners, to whether to raise them on the top 0.1 percent. As we’ve said before, that’s plain silly. Based on 2009 figures from the Internal Revenue Service, doubling the tax rate for the top 0.1 percent might raise approximately $190 billion a year in additional revenue, or 1.3 percent of gross domestic product -- one-sixth of the deficit reduction economists estimate would be needed to fix the U.S. government’s long-term finances.

To give an idea of the distorting effect of ill-conceived taxes on the rich, consider the 50 percent tax rate for people earning more than 150,000 pounds that Gordon Brown, the U.K.’s last Labour prime minister, introduced just weeks before losing elections to Cameron in 2010. The U.K. Treasury estimated the increase would generate an extra 2.4 billion pounds a year, adjusted for all the people who would respond by leaving the country or designing ways to avoid the tax. If no one changed their behavior, the tax change would raise more than double that amount, 7.8 billion pounds. Cameron’s government says it wants to reverse the 50 percent tax rate, just two years after it was introduced.

There is no single answer to fixing the tax systems of all developed economies, as their tax structures and cultures differ widely. But governments should clearly avoid the temptation to focus on the superrich alone and instead reach down to touch the upper middle classes. Doing so would be politically more difficult, because it would hurt more voters. But it’s the only way to produce the kind of revenue that would really bring down budget deficits.

Just as important, governments should start real tax reform aimed at simplifying overly complex tax codes and eliminating exemptions and loopholes that distort behavior and favor above all the wealthy. That’s an area where tax- resistant Americans and free-spending Europeans may find they have more in common than they think.

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