Raising Tax Rates: How to Get it Done

Between 1990 and 2005, the wage gap between the 95th and 90th percentiles of the earnings distribution rose as rapidly as between the 90th and the 50th. The rise between the 98th and the 95th was also very large (and data limitations prevent going much beyond the 98th). Thus I applauded President Obama‘s campaign promise, and budget proposal, to raise marginal tax rates on the upper tail of the income distribution. But how? It is disturbing to see Democrats, like Senator Baucus, arguing against some of the proposals. Yet I’m sympathetic: for example, phasing out deductions for charity and mortgage interest will reduce charitable giving (the evidence suggests a quite high price elasticity for charity) and will reduce housing demand.

What to do? Be honest: instead of the proposed top marginal tax rate, go to 42 percent; and perhaps kick in the top bracket a little earlier.

In short, don’t phase out deductions or exemptions, just put in slightly higher rates that impose the same tax burden and avoid the price effects on these presumably desirable activities. Conservatives will surely argue that this will reduce incentives to work.

Give me a break: Nearly all the labor economics evidence suggests that labor supply elasticities are very low at the upper end of the wage distribution. The disincentive effects on work effort will be trivial.


Yes, tax the wealthy

However, figure out who really is wealthy before you do so. Someone who has most of his/her income through capital gains is taxed less than someone who trades their time and effort for money. Someone can have low net worth (i.e. a young doctor or lawyer who just finished school with enormous student loans) and be taxed higher than someone who has accumulated wealth over a lifetime, and is arguable much more comfortable and can better afford the higher taxes.

Perhaps we should consider a consumption tax as part of our tax structure to even out these kinds of disparities.

Also, never before has such a high percentage of Americans paid no tax at all. If we are looking at history to guide our tax structure, perhaps we should consider this fact as well.

matt

"Give me a break"

The disincentive effects on work are already revealing themselves!

Fake McDontexist

"Give me a break: Nearly all the labor economics evidence suggests that labor supply elasticities are very low at the upper end of the wage distribution. The disincentive effects on work effort will be trivial."

Just because you CAN take something from someone, doesn't mean you SHOULD. Why should the most productive members of society have such a greater burden?

Mike

As a non-econ major, I'm a little confused about "elasticity". Is the final paragraph basically saying that changing tax rates won't change rich people's desire to work?

And, a few paragraphs up, that changing income tax deductions for charitable giving will change people's charitable donation behavior?

Dr. Tonic

I don't think conservatives will argue that this will reduce incentives to work. I think that conservatives will argue that it does not provide any more incentives to work. Incentives are the only reason they worked in the first place. Conservatives will also argue that those people at the top won't hire as many people if they have less money - seems logical, no?

jonathan

I would go further and say that if you look at the history of marginal rates - for various incomes - they were much higher through all of our income tax history. (I remember when the top rate dropped to 70% in the 1960's.)

I would also argue that two things are related. First, the idea that lower rates would generate more taxes - which works only if marginal rates are much, much higher - has been proven false. One need only look at the charts of national debt versus GDP to see the debt shrank after WWII until the Reagan tax cuts and then it grew as a share of GDP (with a small dip under Clinton). Second, the growing income inequality is a direct result of this fiscally irresponsible tax policy and this silly tax policy has increased the cost burden on Americans to the current unsustainable levels (as in healthcare). The negligible job & income growth is a consequence of the GOP's religious belief in low marginal rates - and I say "religious" because they "cling" to it despite the ample real evidence that it's false.

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Cory

I agree with #1. There is a BIG difference between being "rich" and receiving a high income. As a recent law grad, I can tell you that, while my friends and I have a high income, most of us still have negative net worth (thanks to 6-figure debts, which are not tax deductible). Yet our families are facing increased taxes and lowered deductions (and we certainly do not make the $250k to which the taxes are supposedly limited).

The proposed taxes do not tax "the rich"; they tax those with high incomes. The two are not the same.

C. Larity

Is there evidence to suggest that mortgage deductions have actually encouraged home buying? I would suggest keeping the rates the same, but eliminating nearly all the deductions (though I'd keep the charity deduction intact). Of course, I suggest that while having seen no revenue models that would show the impact of my idea vs. yours.

Billy

At #1,

While taxes on consumption seem like a good idea at first blush, it would discourage consumption (kind of a bad idea right now). Or at least consumption in legal ways. People would just go around typical stores to pay no taxes.

Robert L. www.neolibertarian.com

Your missing one of the main points of the Laffer curve: it is not that people will necessarily work less, it is that they will devote more time and effort to avoiding tax liabilities. This may entail nothing more than hiring more tax attorneys to find new loop holes without any reduction in work.

The money spent on gaming the system and the distortions of investment that result from increased gaming then retard overall economic growth, hurting everyone.

Doctor Gonzo

Here's an idea: eliminate the capital gains tax and treat capital gains income as other income.

Why wouldn't this work?

thomcat00

to Cory, post #7: you can cut the amount of taxes you're paying by finding a lower paying job. The reason you took on a large debt to finance a degree was to enter a high-paying field. Even if the tax rate were flat for all of us, you would still be paying more for your higher earnings. And what, exactly, does changing the marginal rate rate from 36% to 39% actually do to you? It likely amounts to under $3000 of additional taxes annually once you factor in AGI and your filing status. Will you miss it? Probably. Will it put you under water? You may not feel "rich" now as you begin your career, but when you consider your wage differential against median incomes in the US over the course of your career, you will likely feel "richer" than the average person. Then you can make yourself richer still by flipping your earnings from wages to capital gains which will reduce your tax burden for the same income.

I don't have a problem with people earning high wages. people need to understand the dollar impact of marginal rates. I'm continually amused by those who complain about the high tax rates that others suffer when they themselves will not suffer it. I don't believe in soaking the rich, but I do think the burden should be distribute, in part, according to one's ability to pay.

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h

I think everyone agrees with #7. By all means, raise other people's taxes. And cut mine.

AMG

No matter how you slice and dice it, when you increase the marginal tax rate, the private sector has less money to save and invest. By reducing the supply of capital, we can expect the cost of capital to increase, limiting the number of projects organizations can profitably build.

With respect to capital gains tax, it is important to point out that by increasing the tax rate to 40% from 15%, you are almost tripling the taxes on deals done in the US. . . so why should private money develop deals here if deals with a slightly lower risk-adjusted return can be found elsewhere?

Again, we are talking about limiting the capital the market is willing to invest as the wealthy add to their savings.

All in, the argument is whether you think the government can earn a better return than these wealthy, private investors. If you believe the government is better at employing capital, by all means, we are heading in the right direction. If you don't, and you agree with these tax hikes to pay for social programs, you agree to take a haircut on GDP growth so that we can subsidize privileges that ought to be earned (yes, i believe health care and education are privileges to be earned).

Speaking of income elasticities with these privileges in mind, though the income elasticity at the high-earner level is very inelastic, we should look at the elasticities across the board. The less the lower-earning workers have to work for their privileges, the more income elastic they are, and the less productivity you get from them. I suppose this is where I go into my case against unions.

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Karl Marx

From each according to his ability, to each according to his need .

Pay up rich people, and share with everyone, whether they work, or even try. The world owes me a living, says the grasshopper to the ant

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@thomcatoo: "but I do think the burden should be distribute, in part, according to one's ability to pay."

cory's whole point is that his ability to pay is not as great as it appears because you are looking at his gross rather than his net income. his comparatively greater potential earnings are irrelevant because the irs demands tax payment now, concurrent with his loan repayments, not in the future. the taxman views his obligations to them as tribute, not as an investment

Tom

Maybe higher tax rates would have reduced the incentives of investment bankers to burn the midnight oil and create the financial instruments that have plunged the economy into the current crisis.

Probably not.

KB

It'd be great if this blog examined the concept of "rich". What does it mean to be upper class? What does it mean (income-wise) to be middle class? How much money is $200,000 a year compared to average incomes? How much money does the average person with $200,000 a year in earned income have from unearned income or capital gains?

Mike

15% Flat Tax...

I've never understood why we punish success?

armchairpunter

"Give me a break: Nearly all the labor economics evidence suggests that labor supply elasticities are very low at the upper end of the wage distribution. The disincentive effects on work effort will be trivial."

No break given.

How easily quantifiable is the labor purchased with the "extra" compensation paid to the top 3-5% earners? Just how fungible--and susceptible to meaningful assessments of supply elasticity--can this realm of effort be? Are not the distinctions at this level far more qualitative than quantitative? In the off chance that the efforts rewarded by seemingly out-sized compensation packages might produce extraordinary value for (1) the employer who voluntarily pays the compensation with its own money, and (2) the rest of society, why risk diminishing them?

Income disparity is far less a threat to freedom in this country than the efforts of those who find it so troubling.

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