Roll those taxes

Robert Reich suggests a new tax policy for America:

What’s fair? I’d say a 50 percent marginal tax rate on the very rich (earning over $500,000 a year). Plus an annual wealth tax of one half of one percent on net worth of people holding more than $5 million in total assets....If the Democrats stand for anything, it’s a fair allocation of the responsibility for paying the costs of maintaining this nation.

But Greg Mankiw notes:

Realistic optimal tax problems don't usually yield solutions similar to Reich's proposal, even for a social planner who has strong preferences for equality. High tax rates at the top generate a lot of deadweight loss for each dollar of tax revenue. In most standard optimal tax models, a more redistributionist social planner would give more to the poor and higher marginal tax rates for everyone, but she would not focus disproportionately on the the very top of the income distribution. And she would not add an extra penalty to capital accumulation, as Reich is proposing.

This is particularly true because Robert Reich is forgetting about state and local taxes. It might be fair to have the rich pay half their income . . . but when you factor in other taxes, many of them do. My old colleagues moving to New York City from London were frequently heard to say "What is this rubbish we've been talking about America having low taxes? My taxes are higher here!" That's because New York State and New York City together levy an additional income tax of 10% once your income is over $100K, which pushed two-income families above Britain's 40% top tax bracket. A 50% tax rate on top incomes would result, for New Yorkers, in a 60% effective total income tax rate total, with their incomes further eroded by the city's 10% sales tax. Since pretty much the entire increase in inequality in the last few decades seems to have come from a few zip codes in the high tax zones around New York and San Francisco, this matters.

People talking about "fair shares" of tax income often forget to factor in state and local taxes, which, given the geographic income distribution in the country, often produces heavily skewed results.

Meanwhile, the wealth thing is ludicrous. $5 million is the value of a moderately successful family business that throws off a couple hundred grand in income a year. You're going to hand those people an extra $25,000 tax bill each year for the sin of being self-employed? This does not sound like a recipe for enhancing America's singularly dynamic economic performance.