Although it seems doubtful that an individual would choose not to start a company for fear of tax consequences should she become a millionaire—the horror—let’s give this argument its fairest shake. If high incomes are the prize that motivates entrepreneurs, high marginal rates weaken the prize and make it harder for new firms to scale up. Plus, reducing entrepreneurship in one generation might deplete the supply of start-up advisers and investors for the next.
Now let’s lift our eyes from theory and look out into the real world. Does it reflect conservative logic?
I don’t think so.
- The two most important hubs of innovation in the United States are the Bay Area and New York City. But according to the Tax Foundation, California and New York have the 48th and the 49th most favorable business-tax climates in the country. Sky-high tax rates in Mountain View and Manhattan haven’t blunted their advantage.
- Average tax rates on most income groups have been declining since the early 1980s, which you’d think would supercharge start-ups, but the official entrepreneurship rate in the United States has been falling over that entire period.
- The United States has lower marginal tax rates on income than much of the Organization for Economic Cooperation and Development does, but the U.S. entrepreneurship rate is lower than those of many Western and Central European countries.
- When the top marginal tax rates were about 90 percent in the 1950s and ’60s, the U.S. productivity rate was higher, men landed on the moon, and scientists invented the internet, satellites, and the transistor, planting the seeds of the entire computer revolution that now defines innovation.
These anecdotes don’t prove anything magical about high marginal rates, or low marginal rates. Rather, they suggest that if taxes matter, other stuff matters more—such as culture, local professional networks, and the state of scientific research.
As John Fernald, an economist at the Federal Reserve, once told me, economists can’t rule out the possibility that productivity has slowed down recently because “we picked all the low-hanging fruit from the information-technology wave.” If capitalist entrepreneurs want to pluck new fruits of innovation, he said, somebody needs to plant new seeds of scientific research.
Read: The golden age of rich people not paying their taxes
The U.S. government used to do this well. Fracking, which has made the United States the world’s energy leader, came from federally funded research into drilling technology. The latest surge in cancer drugs came from the War on Cancer, announced in 1971. But the U.S. government doesn’t plant seeds like it used to. Federal research spending has fallen from nearly 12 percent of the budget in the 1960s to 4 percent today. If economists want to jump-start innovation in new frontiers, maybe they should obsess more about federal research spending than about a tax rate that would kick in at $10,000,000.01.