Equality, Taxes & Business Growth

Question

First, I'm not an economist - just a regular Joe interested in a small part of the subject. Second, I apologize if this is a better question for the 'politics' stack exchange, but I figured I might get a more thorough/technical answer here.

The question: What is flawed with the following scenario (i.e. what are the downsides or why is it not realistic)?:

1. A government's tax model is hard on the wealthy. For simplicity's sake, let's say it caps an individual's annual income (total via employment, capital gains, gifts or anything else) to $1,000,000 USD. So if they make more than that, the rest goes to taxes (or same-year purchases, I suppose) - no exemptions for this tax bracket.
2. The government invests the additional taxes into education - providing high quality, cheap/free high level education. In theory, boosting the education level of the country as a whole - and hopefully stimulating innovation, etc.
3. Other taxes flow back into businesses - incentives to start and run small businesses. This could keep the markets competitive (plus, no business 'too-big-to-fail' or gross monopolies). Since owners/stakeholders wouldn't profit beyond a point, the focus may go to social/science/tech advances (making a name for one's self), giving back, etc. They could also hire more, use more services, and otherwise stimulate the economy that wat. I suppose you'd need some 'business savings account' to allow large businesses to have a safety net as they could otherwise become unstable.

Anyway, maybe it's just me, but it seems like making $1M/year would still make for a fantastic living and one you could retire on quickly. You'd still see people making 20x what others earn, so the point isn't to completely flatten the social scale, just even it out.

It seems like this would result in:

1. A more just society where the bottom 40% of the nation controls MORE than 1% of the wealth. Obviously you'll still have bums, drug addicts, etc. but that's a reality everywhere so unless it worsens the problem I wouldn't consider that a flaw; and perhaps a rehabilitation system could be funded.
2. Create a more robust economy as you'll have a lot of businesses competing and lots of educated people pushing the limits and as stated before, perhaps looking to higher-minded goals than the bottom-line.
3. A higher standard of living on average - as more people would be educated, employed and contributing to society.

So again - why doesn't this work? What are the downsides? Or is this just the wrong stack-exchange?

Thanks!

Answer 1

To provide some input (which I do not necessarily endorse), the Tax Foundation has used its "Taxes and Growth" (TAG) model to estimate/simulate the effects on USA Economy of Thomas Piketty's proposal that the tax rate for very high incomes should rise to $80$%. The results can be found on a report freely downloadable from here.

Their Key Findings are (quote)

1) If ordinary income were taxed at the top rates of 80 and 55 percent, our model estimates that after the economy adjusts, total output (GDP) would be 3.5 percent lower, wage rates would drop 1.6 percent, the capital stock would be 7.4 percent less, and there would be 2.1 million fewer jobs.

2) If capital gains and dividends were taxed at the new tax rates along with ordinary income, the economic damage would be much worse. GDP would plunge 18.1 percent (a loss of $3 trillion dollars annually in terms of today’s GDP), the capital stock would be 42.3 percent smaller than otherwise, wages would be 14.6 percent lower, 4.9 million jobs would be lost, and despite the higher tax rates, government revenue would actually fall.

3) Although Piketty’s proposed income tax increase may appear to target only upper-income taxpayers, all income groups would suffer from the economic fallout.

4) Our model estimates that the after-tax incomes of the poor and middle class would drop about 3 percent if the higher rates do not apply to capital gains and dividends and about 17 percent if they do.

The reasons that I say that I do not necessarily endorse the above results is that the report provided, although produced by a "Michael Schuyler, PhD" is not a scientific paper -so we do not know what assumptions and structure does their "TAG" model incorporates.

Answer 2

There are a couple answers to your question depending on the scope of your question.

A. If a single country did this, there would no doubt be massive capital flight as those who command much larger incomes than $1 million leave the country to preserve their incomes.

B. If the entire world did this and there was nowhere to escape to, the very valuable may simply spend less of their time working and more of their time on leisure activities. This would rob the world of an enormous amount of potentially productive people. Some would certainly continue to work and do helpful things, but the incentives would be very different. People would generally refrain from doing anything particularly difficult or taxing.

Beyond these two scenarios, your proposal implies that government will direct massive amounts of educational and business funding. The government is famously awful at allocating money, and the inevitable result would most certainly be massive waste and misallocation of resources. Government is not a perfect godly operator, but is an imperfect and flawed mechanism run by mere mortals.