Craig Westover: Taxing the rich would cost us all

  • Article by: CRAIG WESTOVER
  • August 25, 2010 - 7:26 PM

DFL gubernatorial candidate Mark Dayton proposes to balance the state budget largely through "tax fairness." Minnesota's richest citizens, he declares, ought to pay their "fair share" of state and local taxes.

But tax fairness is a moral argument, not an economic one. Dayton's "tax the rich" plan collides with the economic reality that "ought" doesn't necessarily imply "can." We ought to have a fair tax system, but can taxing the rich actually lead to tax fairness? It cannot.

Dayton believes targeted tax hikes will produce only the desirable outcomes he predicts. He ignores a fundamental lesson of economics, which author Henry Hazlitt ("Economics in One Lesson") reduced to a single sentence: "The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups."

That is the difference between good and bad economics, and it's why Dayton's belief that his tax hikes targeting the wealthy will only affect the wealthy without any collateral damage to the rest of us is contrary to reality.

High wage earners tend to be individuals with unique skills and knowledge highly sought after in the marketplace. A nationally known college professor, a talented engineer, a successful school superintendent, a CEO with a proven track record, an entrepreneur with a great idea looking for a place to start a business -- such people are highly mobile and can live and work just about anywhere they choose.

All other things being equal, they choose to work where net income (after taxes), not gross income, is competitive. So to lure highly productive individuals to high-tax Minnesota, and to keep them here, Minnesota employers must pay higher gross salaries so in-demand individuals' net incomes compete with those in lower-tax states. If high-end taxes rise further, so will the high-end wages state employers must pay.

Paying higher wages due to higher state taxes, Minnesota companies are left with only three options.

First, a company can hold down wages for less-skilled workers who have less mobility and negotiating power -- that is, the rest of us. Thus, while everyone might pay the same percentage of their incomes in state and local taxes in Dayton's Minnesota, his tax-the-rich scheme would actually create a greater and more inequitable salary differential than currently exists.

As a second alternative, a company facing higher costs in Minnesota can raise the price of its products, selling fewer units but at a higher margin to maintain its profit. That, too, has negative consequences for the rest of us Minnesotans. As consumers, still paying an average 11.2 percent of our incomes to state and local governments, all Minnesotans will now pay more for the goods and services we purchase, and we will purchase less. When consumers purchase fewer products at higher prices, companies maintain their profits by reducing the size of their workforces. Existing jobs are lost, and new jobs are not created.

Finally, to the extent that competition limits how much a Minnesota company can increase its prices, lower profits from Minnesota operations would be the inevitable result. At the margins, relocation or expansion outside of Minnesota becomes the alternative of next resort, which further diminishes Minnesota's tax base.

The logical economic consequence of Dayton's higher taxes on productivity is less productivity. Less productivity equates to less taxable activity. The higher and narrower the tax rate, the more dampening is the effect on the business climate and economic development, and the less business expansion there is translates into fewer jobs created and more jobs lost.

Emphasizing economic principle in tax policy is not to ignore moral questions about a "fair" tax system. It is about understanding how best to achieve that fairness. No matter how strongly Dayton believes that raising taxes on the rich will create a fairer tax system, the economic reality remains that his plan would most harm the average Minnesotans he most intends to benefit.

Craig Westover is a Republican activist and writer.

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