Debt levels of the United States government are currently estimated at more than $15 trillion, or roughly equal to its annual gross domestic product (GDP). The situation has arisen from spending more than the government collects in annual tax revenue. Currently, there is much debate on how to stem the tide of the rising deficit, and increasing taxes is seen as part of the solution.
Many individuals would prefer to see the government rein in its spending and see this as the only viable solution to reduce debt levels over the long haul. Others are firmly against raising taxes. Even though it would offer some solution, raising taxes isn't seen as making a worthwhile dent in entitlement programs including Medicare, Medicaid and Social Security payouts. There is also a debate over whether higher taxes actually lower tax revenue because it creates an incentive for people to work less and stay at home, rather than pay their hard-earned income to bureaucrats.

What Studies Show
Recent studies have detailed that higher tax rates result in lower tax payments from the nation's wealthier individuals. At face value, it seems logical that working less and paying less taxes is a primary response to higher tax rates. However, one recent study gave a different and more logical explanation.

"The Wealth Report" in a recent edition of The Wall Street Journal cited an academic study from Jeffrey Thompson at the University of Massachusetts that explained wealthy individuals don't work less, but get more creative in finding ways to reduce their taxable income. Selling financial assets such as stocks was specifically cited. Other potential reasons include selling assets at a loss to offset taxable income, or increasing charitable giving and related ways to lower tax expenses.

Tax Rate Vs. Tax Revenue
Another study from the National Bureau of Economic Research looked into the tradeoff of higher tax rates and tax revenue and concluded that it is best to impose low tax rates on the widest base of taxpayers to boost total tax revenues. It also suggested that wealthier taxpayers will shift to tax avoidance strategies and called into question why governments would pursue progressive tax strategies that charge wealthier individuals more than lower earners. Basically, it concluded there is little benefit to governments for pursuing the wealthy because they are quite adept at finding ways to offset taxable income.

Of course, extremely high tax rates are seen as likely to cause any income level to work less. At the most extreme, a tax rate of 100% would surely kill off any motivation individuals have to work hard and get ahead. The Laffer Curve, created by economist Arthur Laffer, attempts to graphically illustrate the relationship between tax rates and total government revenue. Rather than prescribe specific points at which the tradeoff shifts, it does point out that there is a level at which tax rates grow excessively high and start to lower overall government tax revenues. This could stem from working less and the pursuit of tax avoidance strategies.

The Bottom Line
Overall, there is plenty of evidence to conclude that aggressively pursuing a smaller subset of taxpayers is an inefficient means to shore up the tax base. Even if it does increase tax revenues, it has little effect in making a dent on total tax revenues or reducing the massive level of government indebtedness. The rich may not work less as a result of higher taxes, but the end result is the same because it, as well as higher tax rates in general, result in creative ways for individuals to lower their taxable income.

Related Articles
  1. Taxes

    Revisiting the Internet Sales Tax Bill: 2013 Vs. 2015

    Learn about the Marketplace Fairness Act of 2015 being reviewed by congress and the differences between it and the 2013 Marketplace Fairness Act.
  2. Investing Basics

    Internet Sales Tax's Effect on Interstate Commerce

    Find out how a national Internet sales tax could affect interstate commerce, and why some bigger online retailers are lobbying for such a tax.
  3. Savings

    The Worst Financial Problems Ultra-High-Net-Worth-Individuals (UHNWIs) Face

    Understand how the problems of ultra-high-net-worth individuals (UHNWIs) are different from ordinary problems, and identify the unique financial challenges they face.
  4. Retirement

    Americans Are Living Longer, but Social Security Is Not Catching Up

    Find out how Social Security really works, why the system is in trouble and whether retirees are simply living too long for Social Security to remain viable.
  5. Retirement

    How Yearly Taxes on 401(k) Accounts Work

    Learn how your contributions to traditional or Roth 401(k) accounts are taxed, either in the year of contributions or at withdrawal, depending on the type.
  6. Markets

    Hillary Clinton Promises Free College and Higher Wages

    With income inequality on the rise, Hillary Clinton is running on raising the minimum wage, raising middle class wages, and providing free or low-cost college education.
  7. Investing

    Top Tips for Deducting Stock Losses

    Investors who know the rules can turn their losing picks into tax savings. Here's how to deduct your stock losses.
  8. Personal Finance

    Read This Before Taking $10K+ to the Philippines

    There are many reasons why you might need to go to the Philippines with more than $10,000. If you do, follow these guidelines to avoid penalties.
  9. FA

    IRA Tax Mistake? You Still May Have Time to Fix It

    Even if tax day has come and gone, errors still can be fixed through mid-October, including those to do with Roth and traditional IRAs.
  10. Taxes

    Payroll Taxes: Picking Apart Your Paycheck

    Here's what gets deducted from your pay, what your employer pays and where your payroll taxes actually end up.
  1. Are personal loans tax deductible?

    Interest paid on personal loans is not tax deductible. If you take out a loan to buy a car for personal use or to cover other ... Read Full Answer >>
  2. Does a Flexible Spending Account (FSA) cover braces?

    Funds from a Flexible Spending Account (FSA) can be used to cover costs associated with installing, maintaining and removing ... Read Full Answer >>
  3. Does QVC charge sales tax?

    QVC, an American TV network, is registered with states to collect sales or use tax on taxable items. QVC is also required ... Read Full Answer >>
  4. Does a Flexible Spending Account (FSA) cover glasses?

    The funds in a Flexible Spending Account (FSA) can be used to cover most common medical expenses; this includes the cost ... Read Full Answer >>
  5. Are tax brackets adjusted for inflation?

    Each year, the U.S. Internal Revenue Service (IRS) adjusts tax brackets for changes in the cost of living to calculate federal ... Read Full Answer >>
  6. Can a Flexible Spending Account (FSA) be used for a spouse?

    The U.S. Internal Revenue Service (IRS) allows Flexible Spending Account (FSA) funds to be used for qualified medical expenses ... Read Full Answer >>

You May Also Like

Trading Center