Why Should We Tax the Rich?

The orthodoxy that dominates today's Republican Party -- and the ranks of "business-friendly" Democrats -- rests on a simple approach to economic policy. Let's be nice, this orthodoxy holds, to rich people.

Let's be particularly nice at tax time. Let's keep taxes on rich people, conservatives advise us, as low as possible. High taxes on high incomes, they argue, discourage entrepreneurship. No one with a great idea for a new business enterprise is going to start that business, their argument goes, if Uncle Sam is just going to tax away the rewards that a new business could bring.

And the same goes for investors. They're not going to invest in "job-creating" enterprises, the conservative orthodoxy insists, if high taxes threaten to eat away at their potential earnings.

This conservative take of taxes works wonderfully for sound bites -- and totally muddies how our economy actually works. Consider, for instance, the story of Toys "R" Us, the iconic global retailer that has just announced its impending demise after over a six-decade run.

That run started with Charles Lazarus, a World War II veteran who learned the retail trade helping customers in his father's Washington, D.C. bike shop. In the years right after the war, Lazarus realized that all his veteran friends were settling down and raising families. Products for kids, Lazarus figured, had a great future, and in 1948 the budding 25-year-old entrepreneur opened a storefront outlet for children's furniture.

Lazarus would soon add toys to his store's product line and quickly see their awesome sales potential. Parents, he realized, only buy a crib once. But toys break and go out of style. They always need to be replaced. By 1957, Lazarus had opened his first toys-only store. By the mid 1960s, his one store had become a small chain pulling in millions in annual sales. Lazarus had become a classic entrepreneurial success story.

None of this should have happened, according to today's conservative orthodoxy on taxes. In the postwar years, high incomes in the United States faced high tax rates. Income in the top tax bracket -- over $200,000 for a single earner -- faced a 91 percent tax rate throughout the 1950s. That top rate didn't dip below 90 percent until 1964. In 1980, the year Ronald Reagan won the White House, America's most affluent still faced a 70 percent tax on their top-bracket income.

These high tax rates on high income didn't seem to undermine the entrepreneurial spirit of Charles Lazarus. He built his toy business right amid them. And Lazarus didn't build that business out of the goodness of his heart either. He saw himself as a businessman out to make a buck.

"If you're going to be a success in life, you have to want it," he would later tell Forbes. "I wanted it. I was poor. I wanted to be rich."

But "rich" has always been and will always be a relative phenomenon. Yes, Lazarus did face high tax rates in the decades right after World War II. But so did everyone else in his lofty income tax bracket. He remained, after taxes, rich by the standard of his day. He felt rewarded enough to exercise his entrepreneurial talents.

In the 1980s, America's economic dynamics -- and incentives -- would change. The 1981 Reagan tax cut opened a new tax-the-rich-ever-so-lightly era. By 1986, the tax rate on top-bracket income had sunk to 28 percent. America's wealthiest now had opportunities to become wealthier than they had ever imagined. They rushed to seize those opportunities by any means necessary.

Behaving entrepreneurially in the classic sense -- identifying an unmet consumer need, meeting that need with style and panache -- would now not be enough for many of America's wealthiest. Patiently building up a business could eat up too much time. Behaving ruthlessly could pile up the millions quite a bit quicker.

Lazarus would soon demonstrate his ruthlessness. His "tough business tactics," business journalist Eric Clark has detailed, sent Toys "R" Us soaring. Lazarus would leverage his growing market dominance to squeeze toy makers, forcing them to accept payment long after they delivered their goods. He demanded -- and won -- free advertising from manufacturers and preferential treatment over other retailers.

Toy consumers didn't benefit from this squeezing. Neither did Toys "R" Us workers. Lazarus did. In 1987, he pulled in a personal payday of $60 million and ended the year as America's top-paid CEO. He ended the decade with a cumulative compensation of $156.2 million.

Lazarus would retire from Toys "R" Us in 1994 an enormously wealthy man. He had company at the top. The Reagan tax cuts for the rich had concentrated a huge chunk of America's wealth at the upper reaches of the nation's economic summit.

In the fantasy world of conservative economic orthodoxy, this concentration could only be good news. Wall Street financial engineers, the orthodox narrative goes, can parlay the mega millions that tax cuts save rich people into investments that create jobs and prosperity for all.

In reality, Wall Street's financial engineers -- the kingpins of "private equity" -- did not parlay the fortunes of America's lightly taxed rich into prosperity for all. They instead used the investment dollars the rich provided to buy up struggling publicly traded companies and take them private. Their basic gameplan: "fix" the companies and then take them back to Wall Street and make a killing going back public.

But the companies the private equity firms took private typically found themselves stuck paying off the debt the private equity kingpins incurred buying them up. The new private equity overlords would, in turn, try to cover that debt by cutting costs, often by putting the axe to worker pay and benefits.

This "fix" sometimes worked. In other cases, the companies continued to struggle. Either way, the private equity managers won. If no windfall materialized on Wall Street, they would still walk away with millions in management fees.

In the Toys "R" Us story, the private-equity crowd came on the scene in 2005. Two private-equity giants -- Bain Capital, Mitt Romney's old stomping grounds, and Kohlberg Kravis Roberts -- joined that year with a real-estate investment trust to acquire the toy giant for $6.6 billion. Toys "R" Us was struggling at the time with competition from Walmart, and Amazon was coming up quick in the rearview mirror.

Toys "R" Us could not pull away. The company's net debt jumped from a few million in the year before the private-equity takeover to nearly $5 billion in the year after. Annual interest payments jumped to $400 million.

These interest payments, notes a Bloomberg analysis, made new investments that could update the looks of Toys "R" Us stores -- or better lure online shoppers -- much more difficult to arrange. By 2006, Toys "R" Us was spending more on servicing its debt than the company was making on its operations.

Last September, Toys "R" Us filed for bankruptcy. Last month, the company's creditors essentially pulled the plug. Toys "R" Us CEO David Brandon announced on March 15 that the company would be shutting down its 735 U.S. stores. Over 30,000 workers would be losing their jobs.

The company's private-equity investors? They collected $470 million in fees from Toys "R" Us during their ownership tenure.

And Charles Lazarus? The 94-year-old died on March 22, one week after the Toys "R" Us shutdown announcement.

Lazarus died rich. One sign of the size of his fortune: In 2013, the "toy king" sold one of his homes, a Fifth Avenue duplex in Manhattan, for $21 million.

The Lazarus heirs, meanwhile, won't have to worry about losing much of their inheritance to federal estate taxes. Thanks to conservative tax-cut orthodoxy, estate tax rates now stand at a modern-day low.