A look at U.S. tax rates at the top

As the 2016 U.S. presidential election campaign inches forward, there’s more and more conversation about tax rates on the highest incomes. Tax rates, of course, have long been at the center of public debates, and the discussion about tax rates touches on a number of issues important to economic policy. Not only do higher tax rates affect the level of inequality, but they also determine the amount of revenue available to the government. In other words, it’s a matter of how much the government gets and who it gets it from. So as the debate continues, taking a quick look at taxation at the top might be helpful.

In a recent piece for The New York Times, Patricia Cohen tries to estimate how much the government could actually raise by increasing tax rates at the top. Cohen, in contrast to many other pieces about tax rates, focuses on the effective tax rate instead of the marginal rate. (The marginal rate is the rate paid on the next additional dollar; the effective rate is simply the percent of your income that gets paid in taxes.) By focusing on the effective rate, the analysis doesn’t have to consider the interplay between marginal rates on ordinary income and capital gains, and the potential shifting between the two. Nor does the analysis consider the specific loopholes and tax expenditures to cut. Instead it’s a simple account of how much money would be raised by increasing effective rates.

In short, increasing effective rates would raise large amounts of money. Cohen focuses on the top 1 percent of earners, which makes sense as the share of taxable income going to that top rung on the ladder has increased dramatically since the late 1970s. Pushing the effective rate on just the top 1 percent to 40 percent, about 6.5 percentage points higher than its current level, would generate an additional $157 billion a year in tax revenue.

To put that number in context, that’d be a 5 percent increase in the tax revenues the federal government got in 2014, according to the Office of Management and Budget. Focusing even higher up on the income ladder, a 45 percent tax rate for those in the top 0.01 percent—their current rate is about 35 percent—would raise $109 billion a year. That’d be a 3.6 percent increase in total federal revenues.

A 5 percent bump in tax revenues may not sound that large, but as Cohen points out, those additional revenues could fund major proposals such as eliminating undergraduate tuition at all public universities and college. Three times over.

One issue with Cohen’s analysis, however, is that there would be some behavioral responses from taxpayers at the very top. How they would react and by how much would have a big impact on the level of inequality and perhaps the pace of economic growth. Research by economists Thomas Piketty at the Paris School of Economics, Emmanuel Saez at the University of California-Berkeley, and Stephanie Stantcheva at Harvard University argues that taxpayers wouldn’t work less or less hard. But perhaps those at the top would put less effort into trying to bargain for ever-higher salaries. That decline in bargaining would reduce their income—and therefore pre-tax income inequality—without really affecting economic growth. Now, taxes alone seem unlikely to take on the lion’s share of reducing income inequality, but it’ll certainly take an important share.

Of course, knowing which effective rates we might want to target leaves us with the question of how we’d get to those rates. Increases in marginal tax rates, cutting exemptions, or some combination of those two are needed. The mix of those options is certainly up for debate.

October 20, 2015


Nick Bunker


Individual Taxation

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