"Soak the rich" rhetoric has been part of American political discourse for as long as I can remember. Two tax plans, at opposite ends of the country, are about to show us the practical limit of this rhetoric. In Washington, President Bush introduced a massive tax cut. In California, Governor Gray Davis introduced a massive tax hike.

Democrats and liberals usually insist that the rich pay more and more taxes. So I was surprised to see Governor Gray Davis, of all people, calling attention to the fact that the rich pay most of the income taxes in California. Davis pointed out that California's tax revenue has been extremely volatile because the incomes of the rich have been volatile. The state's treasury did very well during the dot.com boom of the nineties precisely because that boom put so much money into the hands of the richest people. Between capital gains on stock, and incentive stock options, the state of California collected an unprecedented amount of revenue in 1999.

But this past December, well after he was safely re-elected, Davis began saying we need a source of revenue that is not dependent on such volatile sources of income. We can't allow the welfare of the entire state to be dependent upon the fortunes of a handful of very rich people. When he began making these arguments, I was intrigued as to where a liberal Democrat like Davis might be going with this. After all, at the national level, the Democratic Party was already beginning to attack George Bush for giving tax breaks to the rich. Could it really be that Gray Davis was going to create some kind of tax benefit for Jerry Yang, Barbara Streisand, Larry Ellison, and all the other Very Rich People that fuel the state treasury?

First, let's check out the bare facts. The rich do pay the lion's share of taxes, both at the federal level, and in the state of California. In California, taxpayers with adjusted gross incomes of over $100,000 make up the top 11% of taxpayers. This highest earning group reported 54% of the total income in the state and paid 80% of the state's income taxes. Taxpayers with incomes over $500,000 account for less than 1% of total tax returns filed, but pay about 40% of the personal income taxes paid in the state.

Tax returns at the federal level reveal a similar, though slightly less skewed, pattern. According to the Tax Foundation, the top 10% of U.S. taxpayers earned over 46% of the adjusted gross income in 2000. These same top 10% of households paid 67% of the federal personal income taxes.

Liberals typically call attention to the first of these pairs of facts: the rich earn most of the income. The distribution of income is skewed toward the rich. This fact is a weapon in the liberal argumentative arsenal. Continually repeating, "the top 10% earn 46% of the income" in the U.S., or "the top 54% of the income" in California, seems a compelling case for taxing the rich.

But these same liberals usually overlook the second fact: the rich already pay most of the taxes. Progressive tax codes impose higher percentage taxes on higher levels of income. So this kind of skew is an inevitable feature of any broadly based progressive income tax system. Some people are philosophically opposed to any redistribution at all. But apart from these few advocates of pure meritocracy, most Americans have made their peace with this feature of the progressive tax code.

These bare facts mean that any significant change to the income tax will have a disproportionate impact on the rich. They do pay most of the taxes. If government is going to decrease its income tax revenue, they have to give it back to the top of the income ladder, because that is where most of it came from in the first place. This is the basic arithmetic of the Bush tax plan.
If the rich are already paying the largest proportion of the income taxes, what can you do if you need more tax revenue? There are really only two choices: tax the rich some more, and become even more dependent on their good fortune. Or, tax everybody else.

When we started hearing this at the end of last year, some of us cynical economists suspected he was softening up the public for a massive tax increase on the middle class. And sure enough, he has proposed a one-percentage point increase in the sales tax, expected to raise $4.58 billion. The sales tax is one of the more broadly based taxes, one of the taxes that everybody has to pay. But that is only another way of saying that it is not paid primarily by the rich.

Why does California need so much revenue? The state of California was flush with revenue during the dot.com boom of the 1990's. Gray Davis spent all that money while he had it, adding 44,494 new state employees to the payroll. Now that incomes of the very rich have dropped off with the stock market, Davis is in a tizzy, trying to replace all that money. Cutting state government employment is barely on his radar screen.

By taxing rich people for such a high percentage of the state's revenues, the government hitches its wagon to their star. If the rich flourish, the government will be flush with revenue. If the rich tank, the government's coffers dry up as well. There is a natural limit to "soaking the rich", and California may have just hit it.