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.