A new paper suggests that the ideal tax rate for the richest Americans is 70 percent -- double the current top marginal rate. Here's the thinking, step by step:
1) If you want to make the whole country better off, the rich should pay more taxes, because one more dollar (or, the next "marginal dollar") is more valuable to somebody making $201 a week than to somebody making $20,001 a week.
2) If you want progressive taxes, the optimal top rate is the one that raises the most amount of money.
3) That rate isn't 100 percent, because at that level, people stop working, hide money, or move out of the country. The right rate isn't 10 percent either. Even if you encourage people to make boatloads of money, it's too low to raise much revenue. So the ideal level is somewhere between 10 percent and 100 percent.
4) According to a new Journal of Economic Perspectives paper on taxes by Peter Diamond and Emmanuel Saez, the ideal tax rate for soaking the rich -- i.e.: the number after which higher taxes discourage work and/or shrink the base of taxable income -- is 73 percent.
Today's the top income tax rate is 35 percent. When you factor in other federal taxes, you're at about 42 percent. So we're talking about doubling or almost doubling the top tax rate on the rich. How crazy is this?
Maybe not crazy, says Ezra Klein, who points out that the top tax rate has been above 70 percent before, and the economy averaged better than 4 percent growth.
There are two ways you can interpret this graph. One is that high marginal tax rates seem to create growth! That's probably wrong. Two is that high marginal tax rates coincided with, and did not constrain, years of high growth in the 1950s and 1960s. That sounds more like it.
At the end of the day, this is about creating jobs. So let's talk about the job creators. What would happen if we raised their the top marginal income tax rate to around 70 percent? Paul Krugman says it's nothing to worry about. Adam Ozimek responds that higher taxes mean less incentive to work and make new stuff. I agree with Adam.
Higher taxes on income might discourage work the same way higher taxes on cigarettes discourages smoking. Taxes send signals. But other things send signals, too. Let's say you're a young person with an idea. You might want to start a company. What are your concerns?
Starting a company is really risky. Especially compared to joining a consulting firm. But some things make it less risky. Not having to worry about super-expensive health care, for example. Or having less student debt. Or having access to cheap start-up capital, and tax-free donations. Subsidizing these things costs money. Money comes from taxes. We'd have more money if we had higher taxes -- the same higher taxes that might also discourage some investment and start-ups in the first place.
The bottom line is that this is really complicated stuff, and don't believe anybody who says otherwise. An entrepreneur-friendly capitalist society doesn't mean cutting taxes and calling it a day. It also doesn't mean creating a bed of socialism for every person who claims to be an entrepreneur. It means understanding what job creators need and building a tax code that strikes a balance between efficiency, smart incentives, and fair allocation of after-tax income. Optimizing our top marginal tax rate is a fine step toward that goal, but it's not the most important thing. Not even close.
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