Congress passed a luxury tax to ‘tax the rich’, but it brought in no revenue because ‘the rich’ changed their behavior

Recently, I wrote about how an attempt in California to ‘tax the rich’ ended up bringing in only half the revenues forecast. The reason is simply that taxes are incentives and if you change the incentives you change behavior. Any forecast of tax revenues which doesn’t take this into account is worthless.

An example of this is the luxury tax enacted by Congress in 1991. As economists Roger LeRoy Miller, Daniel K. Benjamin, and Douglass C. North explain in their excellent book The Economics of Public Issues,

Members of Congress were looking for additional revenues to reduce the federal budget deficit. What better way to raise the hoped-for revenues than with new taxes on on the purchases of high-priced luxury items, such as big boats, expensive cars, furs, planes, and jewelry. After all, rich people don’t really care how much they pay, right? So Congress passed a 10 percent luxury surcharge tax on boats priced over $100,000, cares over $30,000, aircraft over $250,000, and furs and jewelry over $10,000. 

The federal government estimated that it would rake in $9 billion in extra revenues over the following five-year period. Yet just a few years later, the luxury tax was quietly eliminated. Why? Because the actual take for the federal government was almost nothing. 

Rich people, strange as it may seem, react to relative price changes, too. For high-priced new boats, for example, they had alternatives. Some bought used luxury boats instead of new ones. Others decided not to trade in their older luxury boats for new ones. Still others bought their new boats in other countries and never brought them back to the United States to be taxed. The moral of the story for politicians is that the laws of supply and demand apply to everyone, rich and poor, young and old, whatever their description might be. 

If you think that you can raise taxes on ‘the rich’ and that ‘the rich’ won’t alter their behavior to accommodate this, you need to think again.

John Phelan is an economist at the Center of the American Experiment.