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January 18, 2004

How Taxes Change Pre-Tax Inequality

Matthew Y makes a really smart point on why tax policy matters, not just in redistributing income but in changing how corporations structure their wage investments:

The key point here is that the tax code alters how companies choose to invest their wage expenses. Consider that if the US had a 100% tax rate on salaries above $300,000 that nobody would make $320,000 per year. The company would be spending money without purchasing any additional labor from their employee. Better to take that $20,000 and spend it on something else, perhaps hiring someone else at $20,000 a year. If you reduce the rate to 99% or 95% or 90% a similar dynamic still applies -- it's very inefficient for a company to spend $10 in order to buy just $1 of my labor, and that's what happens when there's a 90% tax rate. Better to either do more capital investment, hire more low-wage workers (thus tightening the labor market and raising pay at the bottom), or raise the pay scale for people making income that's taxed at a much lower rate, thus getting more bang for your salary buck.
This emphasizes a larger point that progressives need to concentrate far more on how policies structure inequality long before tax and spending policies kick in. If a company has the incentive to raise wages for the working poor and cut CEO compensation, that means that the federal budget can tax less and spend less-- call it cheap liberalism :)

Posted by Nathan at January 18, 2004 09:27 AM