Does a 70% Top Marginal Tax Rate Make Sense?
Tax Proposal Analysis
The runup to the 2020 presidential election is here, and with it comes a bevy of fiscal policy proposals. These plans will give Americans much to ponder over the coming electoral years.
Tax policy, in particular, provides fertile ground for reform proposals.
Foremost among those proposals is an idea that gained traction after freshman Representative Alexandria Ocasio-Cortez (D-NY) promoted it on 60 Minutes last December. Rep. Ocasio-Cortez called for a sharp increase in top marginal tax rates, up to 70 percent for the highest earners.
While not a declared presidential hopeful herself (she is too young to be constitutionally eligible), Rep. Ocasio-Cortez’s ideas have sparked enough conversation and controversy to have outshined the proposals of seasoned political veterans. Others have followed her lead; a 70 percent top marginal tax rate has been embraced by presidential candidates such as former Secretary of Housing and Urban Development Julián Castro and Senator Elizabeth Warren (D-MA).
Her ideas, therefore, deserve serious analysis. A recent Mercatus policy brief, “The Cost of a 70 Percent Marginal Tax Rate,” by Veronique de Rugy and Jack Salmon, dives deeply into the problematic economics of utilizing a high income tax rate to reduce inequality and increase revenue.
What Is the Proposal?
First, it is important to separate Rep. Ocasio-Cortez’s proposal from some of its more uninformed critiques. She did not propose to tax 70 percent of all $10 million in income (or whatever the threshold turns out to be), which would be a tax bill of $7 million in this example. She was very clear that she was talking about marginal tax rates; that is, the tax percentage that kicks in on every dollar earned over a certain amount.
While the tax proposal is not as draconian as some of the knee-jerk reactions suggested, it would nevertheless be a radical departure from recent tax rate trends. Currently, the top marginal tax rate for single filers is 37 percent for over half a million in income. For joint filers, the income threshold is $600,001.
That is not to say that the idea to raise the top marginal tax rate to 70 percent does not have institutional support.
Economist Paul Krugman came out with a ringing endorsement of a high marginal tax rate, noting that other influential economists like Peter Diamond and Emmanuel Saez have estimated the optimal top tax rate to be 73 percent. Saez and fellow University of California, Berkeley economist Gabriel Zucman supported Rep. Ocasio-Cortez’s plan in an op-ed for the New York Times (both economists are advising Sen. Warren on her wealth tax plan). Christina Romer, formerly head of President Obama’s Council of Economic Advisors, advocates for an 80 percent tax rate on top earners.
Krugman makes three general arguments.
First, he says that a 70 percent top marginal tax rate is well within historical norms. If anything, according to this view, the relatively low current tax rates are the aberration.
Next, such high progressive income taxes promote economic equality, according to Krugman. This is because of diminishing marginal utility. Ultra-wealthy people have lots of money. This means that the increase in satisfaction from adding one additional dollar is much lower than an equivalent transfer for a poor person. Therefore, social utility is maximized by redistribution, and the income gap is narrowed to boot.
Finally, Krugman preempts argumentum ad absurdum challenges. His first two points do not imply that we should tax the rich of all of their money. Rather, he argues that we should tax them only as much as it benefits government revenue. Taxing them too much risks wealthy people cutting back on productivity or moving elsewhere. This is why some economists estimate top marginal tax rates of 70 or 80 percent and don’t just advocate confiscating everything over a certain high threshold.
What Do Critics Say?
The picture is a little more complicated than these endorsements might have you think.
First, there is the question of historical comparison. Supporters compare Rep. Ocasio-Cortez’s 70 percent top tax rate plan to historical rates between 1936 and 1981, implying by juxtaposition that high taxes on top earners are as American as apple pie. Only by dramatically increasing taxes can we harmonize ourselves with our traditional fiscal set point, the thinking goes.
This comparison is deeply flawed, argues Philip Magness at the American Institute for Economic Research, because it fails to distinguish the statutory tax rate that is on the books and the effective tax rate that people actually pay. The charts that Krugman and others have used to show a purported progressive tax golden age do not account for the many exemptions, deductions, and legal shelters that constitute the effective rate paid.
The difference between statutory and effective tax rates can be extreme. Magness provides the example of a millionaire filing taxes in 1963, who would have faced a record high statutory rate of 91 percent. That looks pretty bad on the books, but the average effective tax rate for a millionaire in 1963 was actually a hair over 40 percent of their adjusted gross income—much closer to today’s on-the-books 37 percent than the imagined redistributive utopia of yesteryears.
It is true that effective rates at times inched over 50 and 60 percent, even nearing 70 percent towards the end of World War II. But it is simply untrue that high-earners paid well over a 70 percent marginal tax rate on income throughout most modern US history.
In fact, the United States actually collects a larger percentage of its GDP in federal income taxes now than it did during the 50s and 60s. De Rugy and Salmon note that today’s income taxes amount to 8.2 percent of GDP, while only 7.2 percent of GDP was collected during the supposed high-tax heydays of the 1950s, and 7.6 percent was collected during the 1960s.
Then there is the question of effectiveness. Could such a tax rate scheme generate the amount of revenue needed to fund ambitious spending proposals like single-payer healthcare or a Green New Deal? And could it meaningfully reduce income inequality?
The Washington Post enlisted several tax experts to do a rough calculation of the fiscal effects of Rep. Ocasio-Cortez’s proposals. They estimate that a 70 percent marginal tax rate on filers earning more than $10 million would generate $720 billion in revenue over the next decade. (A more conservative estimate from the Tax Foundation predicts a mere $60 billion.) While $72 billion a year in new revenues may sound like a princely sum, it amounts to a ho-hum 3.6 percent increase in federal revenues.
That’s hardly enough to make a meaningful dent in our federal debt, let alone to fund a wholesale reengineering of American life and production.
We still don’t know how much a Green New Deal would cost. But we can compare it to a similar measure proposed by former presidential candidate Jill Stein, which would have conservatively cost $7 trillion over ten years. (Quartz notes that Stein’s vision was far less ambitious than Rep. Ocasio-Cortez’s, so the latter’s Green Deal might cost a lot more green dough.) This cost exceeds the revenue projections by at least a factor of ten. While supporters of expensive proposals like the Green New Deal have since argued that “Modern Monetary Theory” removes the need to fully fund such projects with tax revenue, economists, like Scott Sumner, have noted that there is reason to be skeptical of those claims.
Would 70 Percent Top Marginal Rates Reduce Inequality?
As Mercatus Center faculty director Tyler Cowen notes, the super-wealthy do not earn most of their income from labor. Rather, their wealth comes from capital gains and other such sources, and it would not be too affected by a high top marginal income tax rate.
To the extent that they would be affected, the super-wealthy are fairly mobile and could choose to pack up and head to more hospitable homelands. (This could shed light on why Sen. Elizabeth Warren’s proposal to tax broad wealth polls better than Rep. Ocasio-Cortez’s narrower tax on labor income.) So it is unlikely that high income tax rates would have the impact on inequality that backers maintain.
Taxing labor income in the way Rep. Ocasio-Cortez outlined creates another problem, as Cowen points out. It can be distortionary if it causes people to shift economic activity away from highly-taxed labor and towards relatively less taxed activities, like financial investing. De Rugy and Salmon point out that high top marginal income tax rates also negatively affects people’s incentives to pursue high-earning occupations.
We have real-world experiments, too; De Rugy and Salmon discuss how Canada’s 2015 increase in the top income tax rate resulted in lower income reporting among top bracket earners and lower federal revenues.
Although Rep. Ocasio-Cortez originally showcased the idea as a way to fund to her Green New Deal, her proposal to raise top marginal income taxes above 70 percent is worth considering on its own.
It has generated much interest, but in the end, the proposal to raise the top marginal income tax rate to 70 percent seems to serve mostly symbolic purposes, as supporter Noah Smith has argued. This may (or may not be) good politics, but it is premised on shaky economic foundations.
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