Marginal Rates: I didn’t ask whether an all-cheese diet is bad for you, I asked if you wanted a cheese sandwich by mattsteinglass
August 23, 2008, 2:18 pm
Filed under: Economics, United States

To answer Ezra Klein’s argument that we could raise taxes on the very rich, lower taxes on everyone else, and still raise more revenue, Megan McArdle notes that “High taxes on a narrow base are about the opposite of optimal tax theory,” and continues:

The top 1% of households, about 1 million in all, have about 20% of national income. They’ve also experienced most of the income gains in the last twenty years. So let’s say we want to fund federal operations entirely out of their pockets. Well, to do so, we’d need an income tax rate of 100%. Even ardent liberals will surely concede that at these levels, the supply-siders are right, and we’ll soon end up with no tax base.

Even a less extreme example–make them pay half the tax burden–ends up with a 50% effective rate on high earners. And to get a 50% effective rate, you need an even higher marginal rate.

Uh huh, but nobody is suggesting we make the top 1% of earners pay half the tax burden. What they are suggesting is this: since, as Megan notes, the top 1% of earners have experienced “most of the income gains” the country has seen in the last 20 years, they should pay a higher marginal tax rate than they did 20 years ago. Not 100% or 50% of the tax burden, but a share that is not only higher than previously was the case, but higher than the current marginal rate would deliver. It’s always easy to start talking about first principles to avoid having to deal with the actual situation, or to sketch out a reductio ad absurdum in a case where obviously nobody is proposing the absurdum. For instance: If low marginal rates on a wide base are ideal, then we should tax everyone a flat 20% with no deductions, right? But obviously there are moral and pragmatic reasons why that’s a terrible idea, and in the real world making decisions about optimal tax rates involves weighing different considerations against each other.

The current top federal marginal rate is 35%, not 50%, so there is plenty of room to increase it without going over 50%. Presumably Megan would want to include state and local income taxes as well, but in few states do those taxes run higher than 6%. Only in someplace like NYC would the top marginal rates for anyone be likely to exceed 50% even if you raised the top marginal federal rate to 40%. This would apply to income over about $175,000 for individuals.

Top marginal rates were about double their current level in the years of the US’s great modern period of wealth accumulation, the ’50s-’60s. They were 2% higher in the boom years of the ’90s. What historical evidence — not theoretical speculation, but historical evidence — is there for the negative effects of top marginal rates over 50% on the US economy? There is however very strong historical evidence that high marginal rates affect income equality, or in other words take a large share of the country’s income away from its most powerful citizens. Here’s a historical chart, via Catherine at the Visualizing Economics blog, of top marginal rates vs. share of income:

There are some very obvious reasons to oppose raising the top marginal tax rate — if you are in the top 0.1% of earners. But for the rest of us, the FY 2009 federal budget deficit will supply 482 billion new reasons to raise those rates.


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