Raising the Top Rate
Both Andrew and I are quoted in a mini-symposium on the revenue-maximizing top income tax rate; that is, the peak of the Laffer Curve, at which point a higher rate would leader to lower revenues.
I declined to offer a specific rate for various reasons: the short-term peak rate is probably higher than the long-term rate, it depends on whether there is an alternative lower rate on capital gains, it depends on the income threshold at which the top rates applies (see below), and various other things. And I certainly don't think that the top rate ought to be based solely on revenue considerations; the rate that maximizes growth is certainly well below the rate that maximizes revenue. That's why I said that we really shouldn't go above 50 percent even if it would raise net revenue, which it undoubtedly would up to a point.
What I think is indisputable is that we could raise the top rate quite a bit before any significant Laffer Curve effect kicked in. I would also add that the main effect insofar as revenues are concerned has to do with legal tax avoidance and changing the composition of income rather than having rich people just stop working or investing. It's pretty obvious from the experience of other countries that rich people will pay very considerably more taxes than they do here before they withdraw from the labor force.
Taxes, Bailouts and Class Warfare
Bruce Bartlett
The controversy over AIG executives' huge bonuses that appear to be coming out of federal bailout money is helping fuel a populist revolt against the wealthy that has been gathering steam for years. It will undoubtedly aid Barack Obama's plans to raise taxes on the upper class. Indeed, yesterday, 85 Republicans joined 243 Democrats to impose a 90% tax on AIG bonuses.
According to Gallup, support for soaking the rich is rising. In 1998, 45% of respondents agreed the government should redistribute income by imposing heavy taxes on the wealthy. This percentage rose to 49% in 2007 and 51% last year.
Harris has found even stronger support for raising taxes on the wealthy. According to a 2008 poll, 62% of Americans believe the government should tax them more heavily. Interestingly, this percentage was higher than that in many European countries, generally thought to be more egalitarian than the U.S. For example, only 51% of respondents in France favored raising taxes on the wealthy.
Even Rasmussen, which produces results that are often favorable to the conservative point of view, found in a February poll that 51% of Americans say Obama's plan to raise taxes on those making more than $250,000 will be good for the economy; 31% disagreed. This month, Newsweek found 49% favoring the Obama plan and 42% opposing it.
Such results are confirmed at the state level. According to a Quinnipiac poll in February, 79% of New Yorkers favor a higher tax rate on those making more than $1 million, with just 18% opposed. When the threshold is dropped to $250,000 per year, 56% of voters continue to support the proposal, with 40% against.
We may be entering a new era of class warfare not seen since the 1930s, when Franklin D. Roosevelt went after the nation's wealthy as a deliberate political strategy. According to historian Arthur Schlesinger Jr., Roosevelt explained his purpose in these words:
I am fighting Communism, Huey Longism, Coughlinism, Townsendism. ... To combat this and similar crackpot ideas, it may be necessary to throw to the wolves the 46 men who are reported to have incomes in excess of $1 million a year. This can be accomplished through taxation.
On June 19, 1935, Roosevelt asked for sharply higher income tax rates and estate taxes on the wealthy. In his message to Congress, he said:
Even Rasmussen, which produces results that are often favorable to the conservative point of view, found in a February poll that 51% of Americans say Obama's plan to raise taxes on those making more than $250,000 will be good for the economy; 31% disagreed. This month, Newsweek found 49% favoring the Obama plan and 42% opposing it.
Such results are confirmed at the state level. According to a Quinnipiac poll in February, 79% of New Yorkers favor a higher tax rate on those making more than $1 million, with just 18% opposed. When the threshold is dropped to $250,000 per year, 56% of voters continue to support the proposal, with 40% against.
We may be entering a new era of class warfare not seen since the 1930s, when Franklin D. Roosevelt went after the nation's wealthy as a deliberate political strategy. According to historian Arthur Schlesinger Jr., Roosevelt explained his purpose in these words:
I am fighting Communism, Huey Longism, Coughlinism, Townsendism. ... To combat this and similar crackpot ideas, it may be necessary to throw to the wolves the 46 men who are reported to have incomes in excess of $1 million a year. This can be accomplished through taxation.
On June 19, 1935, Roosevelt asked for sharply higher income tax rates and estate taxes on the wealthy. In his message to Congress, he said:
Social unrest and a deepening sense of unfairness are dangers to our national life which we must minimize by rigorous methods. People know that vast personal incomes come not only through the effort or ability or luck of those who receive them, but also because of the opportunities for advantage which government itself contributes. Therefore, the duty rests upon the government to restrict such incomes by very high taxes.
In truth, there was less to Roosevelt's efforts than it appeared. As historian Joseph Thorndike points out, the heavy lifting in terms of raising taxes on the rich was actually done by Republican Herbert Hoover. In 1932, he raised the top rate to 63% from 25%. The threshold for paying the top rate went up to $1 million from $100,000, but the threshold for paying the 25% rate fell to $38,000 from $100,000.
Roosevelt's 1935 tax increase raised the top rate to 79%, but also sharply raised the threshold to which the top rate applied to $5 million ($76 million in today's dollars). According to historian Mark Leff, there was only one person in the United States who paid even a penny of taxes at the new top rate for the next three years: John D. Rockefeller.
It's important to remember that very few people paid any federal income taxes in those days. In 1935, just 2.1 million taxable returns were filed, 1.6% of Americans. It wasn't until World War II that the federal income tax affected a large percentage of the population. By 1943, 29.4% of Americans were filing tax returns, about the same as today.
Another thing to remember is that the 1935 tax increase was significantly mitigated in 1938, when Congress lowered the maximum capital gains tax rate to 15% on assets held longer than 18 months. Since most of the income of the very wealthy was in the form of capital gains, the actual effect of the higher income tax rate on them was largely symbolic.
Finally, it is important to note that inflation has greatly affected our perceptions. High tax rates in the past that appear to apply to low incomes actually applied to incomes that were much higher in real terms. The following table illustrates this fact by looking at the taxable income to which the 40% or closest bracket applied and converts it to 2009 (inflation-adjusted) dollars. I picked 40% because Obama is planning on allowing the Bush tax cuts to expire next year, which will raise the top income tax rate from 35% to 39.6%.
Threshold at Which the 40% Income Tax Rate Applies
Selected Years | Taxable Income | 2009 Dollars |
1933 | $68,000 | $1,104,000 |
1934 | $62,000 | $976,930 |
1936 | $56,000 | $850,650 |
1940 | $38,000 | $573,100 |
1941 | $16,000 | $229,815 |
1942 | $10,000 | $129,535 |
1954 | $10,000 | $78,490 |
1955 | $20,000 | $157,570 |
1960 | $20,000 | $142,665 |
1965 | $28,000 | $187,685 |
1980 | $29,900 | $76,615 |
1985 | $47,670 | $93,545 |
1993 | $250,000 | $365,300 |
2000 | $288,350 | $353,560 |
2011 | $383,390 |
Sources: Tax Foundation, Bureau of Labor Statistics, Office of Management and Budget.
As one can see, taxpayers in the past were required to pay 40% in taxes on each additional dollar earned at income thresholds that have varied widely. Despite Roosevelt's 1935 tax increase, a taxpayer still needed to make $850,650 in today's dollars before reaching the 40% bracket.
In the postwar era, inflation raised marginal tax rates relentlessly with little relief from Congress. By 1980, even those making just under $77,000 in today's dollars found themselves in the 40% bracket--a rate that had been reserved for someone making more than $1 million even after Hoover's 1932 tax increase (someone making $77,000 today is in the 25% bracket).
This is why so many taxpayers of modest means were attracted to Ronald Reagan's effort to cut income tax rates across the board. Although liberals continue to decry that his 1981 tax cut as a give-away to the rich, Reagan understood that a large portion of the middle class was being taxed as if it was rich. Interestingly, even after the Reagan tax cut was fully phased-in in 1985, the 40% bracket began at an income substantially below what will be the case in 2011 when the Bush tax cuts expire.
Keep in mind that expiration of the Bush tax cuts won't reduce income thresholds to their 2000 levels because indexing of brackets is a permanent feature of the Tax Code. The IRS has already determined that the threshold for the top rate will be $372,950 for 2009. Since the anticipated higher rates will apply to income earned in 2011, I have multiplied this figure by the estimated inflation rate between now and 2011, as published in Obama's budget, to calculate the threshold for the top rate that year.
Too much commentary on taxation from the conservative side treats changes in the top rate as the be-all and end-all of tax policy. But it's important to know what income the tax rate applies to. This is especially important when comparing tax rates today to those in the past. It is essential to adjust tax thresholds for inflation before drawing any conclusions.
Raising the top rate to 39.6% is a bad idea, but it is not the end of the world and may be a small price to pay to avoid even more punitive taxes on the wealthy that appear to have widespread support. It should be remembered that as recently as 1986 the top rate was 50% and the 40% bracket applied to those with a real income one-fourth of what Obama proposes.
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These aren't quite
These aren't quite apples-to-apples comparisons over time when you factor in payroll, state income tax levels and sales tax levels. Isn't it fair to say that the marginal rate for above $500k is currently pushing 50% already when factoring in these taxes? Makes your comment about significant room to the upside in tax rates without any significant Laffer curve effect puzzling.
"the short-term peak rate is
"the short-term peak rate is probably higher than the long-term rate"
If one assumes the tax being cut has any effect on economic growth, doesn't the long-term peak rate have to be lower than the short-term rate, mathematically? At an absurdly long time frame like 50 or 100 or 200 years, the effect of compounding at a higher growth rate would overwhelm the larger tax rate of the economy growing less rapidly (?)
More brackets?
I don't necessarily support raising the marginal rate on the existing top bracket, but why couldn't we add a couple of new brackets on top of that? It seems absurd to me, in a time when the top 1% and top 0.1% are capturing an ever increasing share of national income, for the income tax to stop being progressive at $370k/yr. Why should a person making $400k face the same marginal rate as someone making $40 million? I would add in a bracket at around $500-600k with a rate incrementally higher, say 2-3% higher than the current top rate, and add in a second bracket starting at around $3 million that was sharply higher. I'd also make the tax rate on dividends and capital gains be progressive. If we want those rates to be lower than the rates on ordinary income (which I don't necessarily agree with but will accept for the moment), fine, but why not give them a progressive rate structure?
More Rates
I agree with adding additional rates. This would be particularly appropriate since many couples in the 250K+ "rich" category are professionals or small business owners who essentially pay SSI on each person's entire income. At a higher bracket (say 500K) the marginal rate would be lower even if there was a 5% surcharge.
Being a resident of high tax NJ, my wife and I pay at the AMT rate, so the nominal rate really is less than what we actually pay. I think if you look at real marginal rates (SSI+Medicare+State Tax+ Fed Tax) you will find that couples in the 200-300K range pay the highest rate ---- Higher than people making 100 times.
Cutting Tax Rates Does Not Speed-Up GDP Growth or Investment
Period # of High Top Low Top Average Real GDP Average
Years Tax Rate Tax Rate Top Tax Growth Investment
Rate Rate As % of GDP
1950-63 14 92% 91% 91.1% 4.03% 21.27%
1964-81 18 77% 69.1% 71.1% 3.53% 20.55%
1982-87 6 50% 38.5% 48.1% 3.39% 18.45%
1988-92 5 31% 28% 29.2% 2.53% 17.26%
1993-02 10 39.6% 38.6% 39.45% 3.38% 16.81%
2003-07 5 35% 35% 35% 2.79% 14.40%
Although it is important to remember...
... nobody ever paid those top tax rates on the order of 70% to 90%.
If fact, during the years of those so-high top bracket rates the very highest-income individuals paid lower effective tax rates than those with lower incomes -- the richest actually paid lower tax rates than the less rich.
This is because tax rates at that level create *huge* incentives for the rich to buy loopholes in the tax code, and for politicians to profit by selling them ... starting with preferential tax rates for capital gains (which always existed until Reagan/TRA '86 eliminated them) and moving from there to the massive tax shelter industry of yore, largely forgotten today (after being largely eliminated when Reagan/TRA '86 droped the top rate to 28%).
For instance, Nobelist William Vickery computed from IRS data effective tax rates by income level for 1965 (tax actually paid/income, 1965 dollars) of:
>$1 million: 30.8%
$500k to $1,000k: 32.8%
$100k to $500k: 36.4%
$50k to 100k: 31.2%
So people who had income of $50k to $100k paid a higher effective tax rate than those who had twenty times more income.
The idea that back in the days of the 70% to 90% top rates "the rich" actually paid anything like those rates is just left-side nostalgia for a time that never was.
But after TRA '86 slashed rates and widely broadened the tax base, the richest actually *did* pay the highest effective tax rates of all.
BTW, Vickery was no "conservative" -- he was so old-Keynesian left that he wanted to price and wage control the entire economy to be able to permanently overheat it with massive deficit spending sufficiently to drop the unemployment rate to 2%.
But even he, after studying the progressive income tax, decided it was basically a political sham to help rich special interest groups, and proposed a much flatter tax system as a truly progressive alternative.
Marginal Tax Rate
I agree with Bartlett's judgement about the 50% top rate; however, in a sense we're already about to exceed that. If one considers, for example, the federal and California state tax rates if the administration does not re-enact the Bush tax cut on marginal income:
Federal 39.6%
Calif 10.3%
Health bill surcharge 3.8%
Total 53.7%
Even with effect of the limited deduction of state tax, it's well over 50 percent. So, is Bartlett for re-enactment of the marginal tax rate cut so that it stays at 35 percent?
Yes, high-income Californians
Yes, high-income Californians (and in fact residents of most states with income taxes) already face a top marginal rate of over 50%. And don't forget to include hidden marginal rates such as PEP and Pease in the calculations. Together, those two phase-outs can create a marginal rate of roughly 2%.
Top rate
Kotlikoff and Rapson in their 2007 study for NBER found that the average marginal tax rate on incomes between $20,000 and $500,000 is 40.3%, the median tax rate is 41.8%, and the standard deviation of all of those rates is 5.3 percentage points. Basically, most of us pay about 40%, plus or minus 5.3 percentage points.
The lower incomes get hit harder with the more regressive sales and payroll taxes and other regressive taxes.
As Bruce Bartlett said above, it really depends on the capital gains tax rate, doesn't it? Most people in the top income bracket have considerable capital gains. Those are currently taxed at much less than the top rate. So the median tax rate actually paid is far less. Plus there are all the loopholes, tax free income etc etc. Anyone paying more than 50% in taxes (even under a 39% Fed top rate has an incompetent financial advisor. Plus the top rate ONLY applies to income above a set level. Income up to that level is taxed at a lower rate.
What is also important is the VALUE one gets from tax dollars. Is it cheaper for a country of citizens to pool the money for public goods and services than individuals going it alone? Where the economy of scale operates, and the public goods and services are utilized, they can be a bargain.
"Average Marginal Tax Rates"
Here, we are comparing apples and pears. The study referred to "average marginal tax rates" and "median marginal tax rates" between $20,000 and $500,000, not marginal tax rates. There is quite a difference. And, the authors attempted to determine the "average marginal tax rate" based on total disincentives to work measured not only by taxes, but FICA, corporate tax, loss of certain means tested benefits as well. I wish economists would stop confusing the issue by using "marginal tax rate" to refer to items that have nothing to do with tax. Having said that, the Laffer effect should be based on all disincentives, whether they are labelled a tax or not. And, we should be concerned about the effect of disincentives not just on top incomes, but throughout the entire income range. Ideally, regardless of income level, no one should be faced with the situation where earning an additional dollar is not considered worth the effort due to the total economic loss associated with earning that dollar, whether that is a tax or loss of a benefit. Seen in this way, there are many situations below the top incomes where the disincentive to work is too high, largely due to loss of (extended) unemployment benefits, means tested benefits such as various refundable tax credits, food stamps, health care subsidies (or mandate penalties), not to mention payroll taxes and possible income taxes. If one would adjust this study to account for more recent and projected developments, such as the additional 3.8 percent surcharge added by the health care bill (this really is a "tax" regardless of the label that was put on it), the projected 4.6 percent increase in the marginal tax rate under the administration's proposals, the increased means-tested benefits recently introduced by health bill and increased state income taxes, one would likely see that even the "average marginal tax rate" and the "median marginal tax rate" as defined in the study are pushing 50 percent. What we should be concerned about is not "average" or "median" rates. In the context of Laffer, we should be concerned that the rate of all these items is not excessive at any point in the total income range. For example, if one considered 50 percent to be the policy limit (as Bartlett presumably does), then the fact that the "average" rate would be 48 percent is no comfort if, say 30 percent of the potentially productive population is subject to rates exceeding 50 percent. We are probably seeing at least some effect of this at the low end of the income scale when one looks at the current unemployment rate versus the current level of job openings.
And, does "it" really depend on the capital gains tax rate? That depends on what "it" means. While the capital gains rate (and the dividend rate) is important, it is important for some different reasons than tax and other disincentives on labor are important. I hope that bakho is not forgetting that we don't have an integrated corporate/individual tax system in the United States. Profits earned by a Subchapter C corporation are taxed at both levels, even if capital gains and corporate distributions are taxed at preferred individual rates.
High tax state residency
No one is forcing any one to live in high tax states like CA or NY. Please pick up and move to a lower tax state and find the same income etc there so your total marginal rate drops below your personal upper rate limit goal. Just because your preference is to live in the best places which carries a high local burden does not mean you should not shoulder your share on the national level. Omaha seems to work well for Buffett, NH has no state income tax or sales tax, AZ and FL have low taxes relatively speaking.
Tax rates are a political
Tax rates are a political calculation (ie which voters do you want to vote for you and which do you want to piss off) not a revenue calculation.
Tax revenues have been very consistent for the last 60 years - 17-19% of GDP - http://greenewable.files.wordpress.com/2008/10/total-federal-government-...
As long as government refuses to cut spending to the 17-19% range; then deficits will remain a structural problem. Ignoring the existing debt problem -- and the not-yet-debt entitlement liability tsunami.
It's the spending stupid!
"Tax Rates are a Political Calculation"
"Tax rates are a political calculation"---that's actually quite right. Here's what Jude Wanniski has to say about that in connection with the Laffer curve: "Point E is not 50 percent, although it may be, but rather a variable number: It is the point at which the electorate desires to be taxed. At points B and D, the electorate desires more government goods and services and is willing without reducing its productivity to pay the higher rates consistent with the revenues at point E".
This point seems to have been lost on most of the economists responding to the Ezra Klein survey.
There is, I think, one consideration missing in the above statement that is important. The statement seems to assume, falsely, I think, that the electorate draws a connection between a dollar of extra tax and a dollar of extra public services or benefits in exchange for that tax. If the government were not allowed to borrow money to provide those immediate benefits and services this connection would be more immediate and valid. However, the American electorate has learned that it need not pay an extra dollar of tax to get that extra dollar of government benefits. It only has to have the government borrow it. The connection between public debt and benefits and taxes has been too remote to have the psychological effect presumed by this formula. It is like a teenager that smokes two packs a day (I did). The cost is not often apparent until decades later and until then, who cares? We're immortal, right? . The flip side of this is that politicians have learned that they don't have to tax to hand out those benefits to get them re-elected. But that's political, too. In the end, reality will force a political choice on us. We're at that point now. The effect of this is Point E is raised a bit higher--not because taxpayers are necessarily willing to pay for extra services, but that they are forced by circumstances to accept reality. Unfortunately, recognition of that reality and its acceptancehas come a bit late.
I'm not so sure that
I'm not so sure that taxpayers are going to be "forced by circumstances" to accept a higher tax burden caused by the historic combo of voter desire for a free lunch; pol deceit; DC/bureaucrat/teatsucker inertia; etc.
That 17-19% range was the range even when the federal govt had high approval levels and marginal rates were higher. Nowadays, DC has all the financial credibility of Enron and the approval ratings of a child molester.
Govt may WANT citizens to chip in a higher % in order to avoid making spending decisions - what else is new, they have NEVER made a difficult spending decision. But the only way citizens WILL chip in more is via a)true force at the point of gun and/or jail cell or b)their own choice. "Forced by circumstances" is not a meaningful phrase.
The former will prove that the federales are despotic and thus that their debt can be repudiated. The latter assumes that the federales have a credibility level that is higher than they actually have (or imo may ever have again).
So it may well be that "the deficit reality" is one that government will have to face - via lower spending. Not one that taxpayers will have to face. At a minimum, I would expect that taxpayers will require the spending cuts first (since it is government that is the non-credible party here) before they decide to chip in more.
Personally, I have no doubt in my mind that the federal government will do everything imaginable to avoid making difficult spending decisions. From a Wag the Dog war to garner bogus support from the populace (war is historically the only time higher tax rates "stick" in producing higher revenue) -- to a divide-and-conquer domestic strategy that risks civil war.
Cutting Tax Rates Does Not Speed-Up GDP Growth or Investment
Sorry about my first try at this. I tried to paste a table and obviously it did not work correctly.
I will leave out the columns listing the number of years in each period and also the High and Low Top tax rates in each period.
Summary of the table's important information.
From 1950 to 1963 the Average Top Tax Rate was 91.1%. Real GDP growth rate was 4.03% and Investment averaged 21.27% of GDP.
From 1964 to 1981 the Average Top Tax Rate was 71.1%. Real GDP growth rate was 3.53% and Investment averaged 20.55% of GDP.
From 1982 to 1987 the Average Top Tax Rate was 48.1%. Real GDP growth rate was 3.39% and Investment averaged 18.45% of GDP.
From 1988 to 1992 the Average Top Tax Rate was 29.2%. Real GDP growth rate was 2.53% and Investment averaged 17.26% of GDP.
From 1993 to 2002 the Average Top Tax Rate was 39.45%. Real GDP growth rate was 3.38% and Investment averaged 16.81% of GDP.
From 2003 to 2007 the Average Top Tax Rate was 35%. Real GDP growth rate was 2.79% and Investment averaged 14.4%.
Please notice that as top tax rates went down so did GDP growth rates and investment rates.
Supply-side economics is based on a fallacy. Business owners do not make the irritional decision to send their money to the government as taxes rather than spending it on plant, equipment or labor since these items are deductable and will eliminate the tax bill.