Happy New Year! As we embrace a new year amidst the ongoing government shutdown (which isn't affecting me at all), newly sworn in congresswoman Alexandria Ocasio-Cortez said in an interview with 60 minutes that top tax rates on the super rich for income above $10 million should be 70%! The conservative blogosphere predicatbly blew up.
This all got me thinking about tax rates again. Back in May of 2017 I proposed a tax plan with a rate of 45% for income above $10 million, far lower than Cortez's 70%. Many have claimed that her rate is far too high. Too "radical" as Anderson Cooper described it. It definitely seems radical, even when you consider that the highest marginal tax rates in the 1940s and 50s were as high as 94%.
Enter Nobel prize winning economist Paul Krugman. In a recent New York Times OpEd, he writes on how many other economists (even some Nobel prize winning ones) calculate the optimal top tax rate to be over 70%:
Peter Diamond, Nobel laureate in economics and arguably the world’s leading expert on public finance. (Although Republicans blocked him from an appointment to the Federal Reserve Board with claims that he was unqualified. Really.) And it’s a policy nobody has ever implemented, aside from … the United States, for 35 years after World War II — including the most successful period of economic growth in our history.
To be more specific, Diamond, in work with Emmanuel Saez — one of our leading experts on inequality — estimated the optimal top tax rate to be 73 percent. Some put it higher: Christina Romer, top macroeconomist and former head of President Obama’s Council of Economic Advisers, estimates it at more than 80 percent.
Krugman continues on how the top tax rates is based on two primary factors: Diminishing marginal utility and competitive markets, [emphasis mine]
Diminishing marginal utility is the common-sense notion that an extra dollar is worth a lot less in satisfaction to people with very high incomes than to those with low incomes. Give a family with an annual income of $20,000 an extra $1,000 and it will make a big difference to their lives. Give a guy who makes $1 million an extra thousand and he’ll barely notice it.
What this implies for economic policy is that we shouldn’t care what a policy does to the incomes of the very rich. A policy that makes the rich a bit poorer will affect only a handful of people, and will barely affect their life satisfaction, since they will still be able to buy whatever they want.
So why not tax them at 100 percent? The answer is that this would eliminate any incentive to do whatever it is they do to earn that much money, which would hurt the economy. In other words, tax policy toward the rich should have nothing to do with the interests of the rich, per se, but should only be concerned with how incentive effects change the behavior of the rich, and how this affects the rest of the population.
Seems reasonable. Tax the rich too high, Krugman argues, like at 100%, and you'll stifle all incentive to work any harder resulting in diminishing returns. But what's "too high" is a threshold beyond an optimal top tax rate that would drive the largest tax revenue, that experts argue is much higher than the top tax rates that currently exist. He continues, [emphasis mine]
But here’s where competitive markets come in. In a perfectly competitive economy, with no monopoly power or other distortions — which is the kind of economy conservatives want us to believe we have — everyone gets paid his or her marginal product. That is, if you get paid $1000 an hour, it’s because each extra hour you work adds $1000 worth to the economy’s output.
In that case, however, why do we care how hard the rich work? If a rich man works an extra hour, adding $1000 to the economy, but gets paid $1000 for his efforts, the combined income of everyone else doesn’t change, does it? Ah, but it does — because he pays taxes on that extra $1000. So the social benefit from getting high-income individuals to work a bit harder is the tax revenue generated by that extra effort — and conversely the cost of their working less is the reduction in the taxes they pay.
Or to put it a bit more succinctly, when taxing the rich, all we should care about is how much revenue we raise. The optimal tax rate on people with very high incomes is the rate that raises the maximum possible revenue.
And that’s something we can estimate, given evidence on how responsive the pre-tax income of the wealthy actually is to tax rates. As I said, Diamond and Saez put the optimal rate at 73 percent, Romer at over 80 percent — which is consistent with what AOC said.
So a 70% top marginal tax rate may not be that radical and ruin all incentive. I've been debating with several conservatives on Twitter recently and it seems that they all make the common conservative argument that any raise to the tax rates will discourage anyone, especially those already wealthy, from working harder. Krugman cites a chart showing the top tax rate and growth rate, which does not show a correlation between lower top tax rates and growth, contrary to what conservative-leaning economists always argue.
In light of all this I'm reconsidering my view on what the top tax rates should be, and my 45% top tax rate proposal now seems awfully low now.
From my blog post:
Federal tax rates for individuals:
Income amount Tax rate 0 – 2,500 0.00% 2,500 – 10,000 10.00% 10,000 – 40,000 15.00% 40,000 – 90,000 25.00% 90,000 – 150,000 28.00% 150,000 – 250,000 33.00% 250,000 – 500,000 35.00% 500,000 – 1,000,000 40.00% 1,000,000 – 10,000,000 43.00% 10,000,000 – above 45.00%
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