Top Marginal tax rate of 70% ?
I agree with Diamond and Saez that the top marginal income tax rate should be slightly over 70%, but I don’t agree with what I take their reasoning to be. My argument after the jump.
They argue that the tax rate should be chosen to maximize taxes collected from the super rich. the argument that we should tax the super/rich to less than the peak of the Laffer curve follows.
The assumptions aren’t even crazy. Assume there are three types of people, the super-rich, the rich and the middle-class. Labor of the super-rich and of the rich are perfect substitutes with the super-rich 10 times as good at everything. Labor of the middle-class and labor of the richandsuperrich enter in production cobb douglass. Reduction of labor supply by the super-rich reduces GDP by their wage. It also causes the wage of the rich to go up and the wage of the middle class to go down. This second effect reduces welfare. At the top of the supper-rich Laffer curve, a tiny reduction in the tax on the super-rich causes the same income of the rest of society and a more equal distribution of that income. So it causes increased welfare. This is true for any fixed tax rates on the rich and the middle class and for tax rates which are adujsted optimally (the second by the envelope theorem).
I haven’t read the paper, but I think that Diamond and Saez must be doing something odd. They consider utils when discussing the income of the rich and equivalent variation when considering the effect of the labor supply of the rich on the rest of us.
There is an argument which seems to suggest that the effect of the labor supply of Mr Jones (“Smith” is already in use in this context) on the rest of us is zero. Standard (false) positive assumptions imply that Mr Jones is paid his marginal product, so the effect of his labor supply on the total income of the rest of us is zero. This means that the effect on money metric not-welfare-at-all is zero. So if we don’t care about the distribution of income and wealth among the rest of us, we don’t care about Mr Jones’ labor supply. So if money can’t help Mr Jones more, we tax him to the peak of his personal Jones/Laffer curve.
But wait the whole point is that we should care a whole lot about the distribution of income.
It is an odd paper and I also have some problems with it. My biggest issue is that it seems to disregard how people behave in the real world (as opposed to what they say in order to play to referees). That is to say, tax rates that are quite low encourage people to “take profits” and consume it rather than reinvest in the business. (Tax rates that are too high encourage people to reinvest too much, beyond the point where there are useful avenues to invest… the Kimel curve analysis I did suggests 65% or so is the sweet spot.)
Their approach is based on people substituting away from working as tax rates get up to the sweet spot. Sure, it makes sense in the context of “higher taxes always dissuade people from working” but it is the opposite of the way decisions really are made.
Excluding payroll taxes, changes in the top marginal rate have not significantly influenced revenues as a % of GDP. See this chart:
In fact the 70% top rate had an equal to lower take than lower top marginal rates historically.
“I haven’t read the paper,”
Could I suggest very strongly that you do then?
“I agree with Diamond and Saez that the top marginal income tax rate should be slightly over 70%,”
Because that isn’t what they say, in any shape or form. Which is a fairly important difference between your agreement with what you think, erroneously, the paper says?
What they actually say is that given the current tax structure the total marginal tax rate (ie, not the income tax rate, but the accumulation of FICA, state taxes, ferderal taxes and sales taxes) the Laffer Curve peak is at 54%. Given a different tax structure it might be as high as 80%.
And, err, that’s the short term rate, not the long term.
I just knew this paper would be misunderstood, used as propaganda, but I just expect better than that around here.
Rob, is it really so important to quibble with their reasons if you agree they’re right? If you haven’t read the paper how do you know their reasoning is wrong anyway? And with so many people out there on the Right wing wrong for the wrong reasons I don’t see what the material payoff is in your complaint about “right for the wrong reasons”
I’m honestly less sure what you are saying here in 3 paragraphs than what they said in 25 pages-which honestly I found a lot more clear
But unless you tell me in a much clearer way what assumption they had that was wrong and why it matters so much I kind of feel like there are better things to get excorcised about.
Incidentally I joined the tax debate as it looked like fun. I assume that everyone from Mike Kimel to Krugman to Diamon-Saez are on the right track-I mean it’s logical that’s what the top rate was in 80 when Reagan came in and over the last 30 years since his huge tax cuts on top rates we have seen increasing economic inequality and a stagnant starndard of living for most Americans.
I kind of look at other ways we could improve the tax structure but taking it from the kinds of reforms a liberal might be able to achieve at the state level. One idea is cutting the consumption tax and another is to radically cut all parking and traffic fees-I am thinking of NY but this could work anywhere of course-at the state. city, and local level.
The principle I argue for here is twofold-in prinicple we should be committed to tax progressivity, the more the better; we also though want at the same time to increase net revenue of the government. These two ideas might sometimes seem at variance. If we cut or even ended the NY State sales tax tomorrow-as it takes a much bigger cut of the nonrich than the rich-it would be a progressive tax cut for that reason but it would also reduce state revenue? Or would it? Isn’t it possible that since the nonrich spend all or most of their income on consumption that a lot of the lost tax revenue would be redirected in a consumption boom that would see retailer revenue and so state tax revenue burgeon?
Forget about maximizing revenue. 80% would be better. The rich have too much power. Just take their money. We’ll see how elite they are without it.
1951-1963 top rate 91%, Revenues collected as a % of GDP 7.7%.
1964-1981 top rate 70%, Revenues collected as a % of GDP 8.0%.
1988-1990 top rate 28%, Revenues collected as a % of GDP 8.1%.
Federal Rev as % GDP just looks at income taxes, it excludes payroll tax.
Mike maybe you can explain why revenues barely budged. Tax rates alone do not explain inequality – people seem to be making a causality argument on this point.