Don’t Count on the Rich

The age-old debate about taxes has reared its head in the cradle of capitalism, New York City. The newly elected mayor, a democratic socialist, has proposed increases to taxes on businesses and folks making over $1 million annually to fund social programs. The proposed tax increases would further entrench New York City among the highest taxed cities in the nation at a time when state and local taxes are not deductible for federal taxes, meaning there would be no tax shield to any increase and rich taxpayers would eat the entire increase.

But here’s the rub. You can’t count on the rich. They just aren’t predictable when it comes to paying taxes.

Any well-run government or highly leveraged business relies on a predictable set of revenues or cash flows to fund its obligations. Predictability is the key.

The following chart depicts the percentage change in annual taxes paid by taxpayers in New York City with incomes both below and above $1 million. The less wealthy cohort shows a somewhat predictable annual tax payment, with annual changes between zero and 10%. Receipts from wealthy taxpayers were much more volatile, increasing by as much as close to 50% and decreasing by as much as 30% yearly, and there’s a reason. The wealthy are different from you and I. Taxpayers who make over $1 million annually rely much more on capital appreciation or capital gains than the rest of us: these amounts can account for over 33% of their total income compared to under 13% for the rest of us wage-earning commoners. However, in really good years, rich folk’s capital gains can account for as much as 45% of income and in bad years as little as 19%. This skews tax collections considerably in New York City and is reflected in the chart below where the change in total collections is dragged above and below the average depending on capital gains flowing to the rich.

As the chart demonstrates, capital gains are unpredictable, and this is because they are highly dependent on the direction and whims of the market and the economy. Things look great today, with asset prices at bubble levels, but a significant decline in asset prices could endanger future collections, putting social programs at risk.

Further, rich folks are also more mobile: they can pick up their ball and move much easier, endangering a significant percentage of tax receipts.

For these reasons, New York City is less dependent on income and business taxes than you might think. In fact, combined, they only make up 20% of fiscal receipts.

Bottom line, if you want to start a revolution, don’t necessarily count on the rich to fund it.