Type to search

Money News Opinion

No, Economists Don’t Agree a 70 Percent Top Marginal Tax Rate Is a Good Idea

Share

Economic commentators
Matt Yglesias
,
Paul Krugman
, and
Noah Smith
believe Rep. Alexandria Ocasio-Cortez’s (D-N.Y.)
call for a 60 to 70 percent top marginal income tax rate is
uncontroversial. According to all three, the New York Democrat’s
proposal simply reflects the consensus of mainstream economics.

Their argument rests on two historical factoids. The first is
that the rich paid higher taxes in the 1950s, and the economy grew
just fine. The second “fact” is that an array of economists, from
Nobel Prize winner
Peter Diamond
, to
Thomas Piketty
and
Emmanuel Saez
, have produced peer-reviewed research showing
combined marginal rates as high as 70 to 80 percent are
“optimal.”

But dig into these
three papers, and you’ll find the
results reflect philosophy as much as economics. These economists
think they can plan the distribution of income to maximize “social
welfare.” But they arrive at the decision to impose extremely high
top marginal tax rates because they uniformly decide to put almost
zero weight on the welfare of the rich.

That means the sole aim of this cluster of economists is to
maximize revenue collected from high earners in order to transfer
to others. Presuming we could design a tax system from scratch that
eliminates the possibility of people avoiding taxes or hiding or
reclassifying income, they estimate the single combined marginal
tax rate that would generate maximum revenue to “soak the rich.”
Incorporating other wishful thinking about how the rich respond to
taxes, these economists wind up calculating that the “optimal” top
tax rate is about 70 percent, if you are also willing to
imagine closing off special treatment for capital gains and the
possibility of incorporation.

The astute reader can probably see some problems with
extrapolating from this theoretical calculation.

First, what if one thinks the welfare of the rich is actually an
important policy consideration? According to
a paper by Jonathan Gruber and Emmanuel Saez
, if we instead
pursued a “compassionate conservative” agenda—caring about
the very poor a bit more than others in society, but everyone else
equally, the optimal top rate might be as low as 30 percent. If we
were philosophically opposed to redistribution altogether, the
optimal rate tumbles to 3 percent. What counts as optimal varies
tremendously based on the philosophical assumptions the economist
starts with.

Second, what if we were not able to redesign the tax code to
eliminate avoidance? A 73 percent rate, the optimal rate calculated
by Diamond and Saez in 2011, is a combined rate (not just a
marginal federal income tax rate, as Ocasio-Cortez seems to be
proposing) that assumes we eliminate all deductions and exemptions.
If we presume instead that the current deductions and exemptions
continue, and high earners were as responsive to tax rates today as
they were in the ’80s, then the supposed optimal combined tax rate
falls to 54 percent. After state, local, sales, and other taxes are
taken into account, this translates to a top federal income tax
rate of 48 percent—much higher than today’s rate of 37
percent, but nowhere near the 60 to 70 percent rate advocated by
Ocasio-Cortez. (Also notable:
Phil Magness
and
Nick Gillespie
have shown, very few people actually paid the
highest rates in the 1950s, precisely because deductions and
exemptions existed that these economists assume we’d be able to
abolish.)

Third, these sorts of analyses tend to focus on (a) the very
short-term, and (b) what to do with income after it’s been
produced. They do not ask why we receive income in a market
economy. (Answer: because we produce something someone else wants
or needs, generating consumer surplus.) The idea that the value of
rich people to the rest of society solely rests on their tax
contributions, as Krugman implies, is bizarre. In fact, the risk
that higher tax rates might deter entrepreneurial activity by
reducing the future payoff to innovation should worry us greatly.

The economist Charles Jones
thinks that incorporating this
effect into the model might lower the optimal tax rate to 28
percent, simply because innovations—think Uber,
Amazon—deliver huge gains to everyone.

This all might seem technical and theoretical, but it matters.
Most of the venerated papers that seem to support super high tax
rates for top earners assume we share progressive preferences, that
we can implement a new wholly combined tax system (or hike other
taxes) to eliminate the possibility of any form of tax planning,
and that these huge tax hikes won’t have longer term effects on
growth or human capital accumulation.

Given all this, Krugman, Yglesias, and Smith could easily have
said, “There’s a progressive case, grounded in economics, for major
tax reform, eliminating all deductions, and having one single
progressive tax with very high rates, especially on top earners.”
But they could instead have said, “There’s a progressive case,
grounded in economics, for modestly higher top tax rates within the
current code.” But they cannot claim simultaneously that
Ocasio-Cortez’s big idea merely echoes the 1950s and that
her recommendation is backed up by these economists.



You Might Like
Learn more about RevenueStripe...
Cato Institute

A public policy research organization dedicated to individual liberty, limited government, free markets, and peace.

  • 1