The Wall Street Journal reported a strange mystery in May, 2009: about one-third of the 3,000 millionaires in Maryland had disappeared. Tax returns in 2008 and 2009 proved it. The number of tax returns from millionaires in Maryland dropped from about 3,000 in 2008 to 2,000 in 2009. The recession no doubt contributed somewhat to this vanishing act, but there is more to it. Governor Martin O’Malley had supported a hike in Maryland’s progressive income tax in 2008 because these rich guys were “willing and able” to pay it.
They may have been able, but they certainly weren’t willing. The soak-the-rich crowd always assumes a static model of taxation: if a state makes, say, $10 billion in income taxes from millionaires and if you raise the rate on them three percent, the assumption is that you will take in another $300 million, because that amount is three percent of $10 billion. The reality is that when federal and state tax rates go over about 25-30 percent, the rich folks simply shift their money into non-taxable investments–municipal bonds, collectibles, foreign banks, and so on. That’s what has happened in Maryland–people with large incomes are shifting their wealth into tax-exempt investments.
We first saw this disappearing act at the federal level after the first large tax hike in U.S. history during World War I. In 1916, with the highest tax rate set at 15 percent, the U.S. had 1,296 tax returns from people with incomes over $300,000 (over $5,000,000 in today’s dollars). By 1921, with the top marginal rate jacked up to 73 percent, the number of tax filers with incomes over $300,000 had plummeted to 246, an 80 percent drop. I discuss this remarkable mystery in my book The Myth of the Robber Barons.
If politicians want to solve the case of the missing millionaires, the solution is to cut tax rates. (A flat tax is also an excellent idea). When politicians have cut the highest tax rates down to about 25 percent, as happened in the 1920s and 1980s, we not only saw the millionaires reappear, but they spawned many other millionaires as they used their money to invest in the economy, and our country prospered. At the same time, the federal government actually received more tax revenue under the lower tax rates than when trying to pretend that the rich were “willing and able” to give huge percentages of their incomes to a government trying to “soak the rich” with high taxes. Lower tax rates lead to more prosperity for the public and more funds for the operation of government — if politicians would only learn that lesson.