After the market began to tumble in March 2000, I rapidly liquidated stocks and thus ended up reporting a one-time surge in capital gains. Although most gains were taxed at a reasonable rate, they were nonetheless included in total income for the purpose of figuring out how all other income is taxed. As a result, every dollar of my middling labor income was taxed at the highest possible tax rate. With the U.S. government practically ordering me to work less, I promptly cut my labor income by another 27 percent in that year alone. I did that by shutting down a consulting business I had run for 10 years. The IRS, which had been collecting about 30 percent of my consulting income, was then collecting 40 percent of nothing.
By 2003, I had managed to reduce my labor income another 36 percent by asking my employer to pay me less in return for less time in the office. Altogether, I have cleverly reduced my taxable labor income by 67 percent from 1997 to 2003. My Medicare tax likewise fell by the same amount, and the Social Security tax fell nearly as much.
Past efforts to tax my wife and me more ruthlessly in 1991-93 had the opposite effect. Yet Sen. Kerry now imagines he can compel us to fork over a much larger share of investment income by reverting to taxing dividends at ordinary income tax rates. Ironically, that would cut my taxes, not raise them. I have only lately begun for the first time to accumulate dividend-paying stocks and funds. If I ever believed dividends would again be taxed at rates of up to 39.6 percent, as Sen. Kerry proposes, I would rush out of dividend-paying stocks and back into tax-exempt bond funds. Instead of collecting 15 percent of something, the IRS would then be collecting at least 30 percent of nothing.
For brave souls who keep working past 65, federal work penalties grow even more severe. Such heroic Americans must keep paying into Social Security and Medicare even though those payments add nothing to their benefits. This is the government's "nothing for something" plan for working seniors. Even a middling salary will also result in 85 percent of their Social Security benefit being taxed, while those who avoid work commonly get tax-free benefits. To make matters worse, money taken out of IRA or 401k plans will normally be taxed at a higher rate if seniors keep working, because income from work puts them in a higher tax bracket.
The sensible solution is to stop working at 62-65, or to work as little as possible -- like running a 12-cylinder engine on 4 cylinders. Yet this is a dangerous message to send to our rapidly aging population. Future growth of tax revenues, and of the economy, will be heavily dependent on whether or not older Americans choose leisure over work.
Between 2000 and 2020, the population between the ages of 25 and 54 is projected to increase by only 3 percent while the population over 55 increases by 63 percent. If older people shun work, there will be virtually no growth in the labor force aside from immigration. America's medium-term challenge is not a shortage of jobs but a prospective shortage of willing and able workers.
Even if only a fraction of future seniors respond in the ways I have to tax penalties on work, money flowing into the Treasury, Social Security and Medicare from an aging workforce will slow even more than expected.
A few years ago, the Russell Sage Foundation (which routinely bankrolls egalitarians) sponsored a collection of papers turning Ayn Rand's opus into a question, "Does Atlas Shrug?" The authors could not get the right answers because they did not ask the right questions. Work effort cannot be measured by hours on the job. Work effort is more like a dimmer switch than a light switch; we adjust it by degrees. And mature, educated taxpayers are not docile sheep but wily foxes. When tax collectors set out to punish extra effort and investment, we get the message.