In today’s Wall Street Journal, Alan Reynolds has an excellent piece on how much revenue can be expected from the Obama tax rate increases to pay for Obamacare. Bottom line: much less than Obama estimates. Reason: elasticity of taxable income with respect to marginal tax rates.

Reynolds does three things:

1. Shows that in the past, the revenues expected from tax-rate increases on the highest-income taxpayers usually fell short of predictions.
2. Shows the margins on which high-income taxpayers will be able to adjust to legally avoid taxation.
3. Reports the academic research on the elasticity of taxable income with respect to marginal tax rates and then estimates on this basis.

An excerpt:

The evidence is surveyed in a May 2009 paper for the National Bureau of Economic Research by Emmanuel Saez of the University of California at Berkeley, Joel Slemrod of the University of Michigan, and Seth Giertz of the University of Nebraska. They review a number of studies and find that “for an elasticity estimate of 0.5 . . . the fraction of tax revenue lost from behavioral responses would be 43.1%.” That elasticity estimate of 0.5 would whittle the Obama team’s hoped-for $1.2 trillion down to $671 billion. As the authors note, however, “there is much evidence to suggest that the ETI is higher for high-income individuals.” The authors’ illustrative use of a 0.5 figure is a perfectly reasonable approximation for most purposes, but not for tax hikes aimed at the very rich.

One quibble, though. Alan uses the terms “high income” and “rich” interchangeably. They’re not the same. One can be high income and have little wealth. I think of an entrepreneur friend who made about $20K a year for about 10 years while building his business and went into $400K in credit-card debt alone. Then he had a few years of a million dollar a year incomes. It took till about his third year of that high income before he became “rich,” defined as having a net worth of one million or more.

It is true, though, that many of the tax-avoidance strategies that Alan suggests work best for those who are not only high-income but also rich. Those who are high-income but not rich will have fewer ways of avoiding the tax hit and, therefore, are less likely to get rich.