I was pretty confident I could come up with a quick answer, and so were a lot of other students. By the end of the hour, after Professor Bittker had politely punched huge holes in every student's definition, it was pretty clear that none of us could. Income is a slippery concept -- especially slippery when you're trying to tax it.
Which leads me to think that Obama may have avoided Tax 1. Or perhaps he dozed off in class. For in his April 13 speech at George Washington University, the speech to which Standard & Poor's responded by reducing the government's credit rating to "negative," he seemed to think he could get all the money we need to balance the budget from higher taxes on the rich.
That's wrong as a matter of simple arithmetic, as is clear from a chart reproduced on the Wall Street Journal editorial page showing the total amounts of taxable income of each group.
The chart showed that if the government had simply confiscated every dollar from those reporting more than $1 million taxable income in 2008, it would not have gotten the $1.3 trillion needed to close the current federal budget deficit.
What the chart doesn't show, however, is even more important. And that is that when you reduce income tax rates, high earners have more taxable income. When you raise them, they have less.
High earners don't sit around waiting to have their money confiscated any more than chickens sit around and let you pluck out all their feathers. They pursue other options.
This is most obvious when you think about capital gains. The federal government doesn't try to tax capital gains -- the increase in values of your stocks or your house -- every year (Professor Bittker had us in knots explaining how it might do this). You pay capital gains on a stock or house only in the year you sell it.
What happens if the capital gains tax goes up from 15 percent to 50 percent? People stop selling stocks and hold onto their houses if they possibly can. And when cap gains rates go down? They're more willing to sell, pay the lower tax and invest in something else.
That's why the government's total revenues from capital gains have tended to rise when the capital gains tax rate is lowered. And why increases in the capital gains tax rate never raises the amount of revenues static models estimate it will.
You get the same effect, to a lesser extent, when you change tax rates on ordinary income. People working for minimum wage don't have many options about how they'll be paid. High earners tend to have more options.
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