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High Tax Rates for the Wealthy

Alicia Munnell, the director of the Center for Retirement Research at Boston College, is a weekly contributor to “Encore.

The Congressional Budget Office projects that, with the current trajectory of taxes and spending, debt will rise from its current level of about 70% today to nearly 95% in ten years and twice that high by 2040. It is inconceivable that we can avoid such an outcome without raising taxes. But the current tax debate focuses on Bush versus Clinton – that is, maximum rates of 35% versus 39.6% – whereas new work by economists suggests that the more relevant debate should be Reagan versus Nixon – maximum rates of 50% versus 70%.

The top 1% is a good place to look for additional revenue. The share of pre-tax income accruing to the top earners has increased from less than 10% in the 1970s to about 20% today. And, as noted above, the tax rate has declined sharply.

Raising rates on top earners has traditionally been thought to produce little revenue. Indeed, the famous backward-bending Laffer curve, which Arthur Laffer drew on a napkin to make a point to Gerald Ford’s chief of staff Donald Rumsfeld and assistant Dick Cheney in 1974, showed that revenues would increase less and less as rates rose and, after some point, revenues would actually decline. The notion is that if rates got too high, rich people would find ways to avoid them; they would work less, shift their earnings to other forms, move money overseas, and otherwise reduce their income. The message was that high taxes would reduce efforts by the rich and reduced efforts by the rich would slow economic growth.

Until recently, the Laffer curve was accepted as gospel. But new research by economist Peter Diamond, the 2010 winner of the Nobel Prize, and Emmanuel Saez, a John Bates Clark medalist for the best economist under 40, and others, suggests that the top rates for high earners could be much higher without hurting growth. The Diamond-Saez research indicates that the revenue maximizing federal tax rate is between 50 and 70 percent, even acknowledging that the rich face additional Medicare taxes and state and local levies. To reduce tax avoidance, tax rates on capital gains and dividends should match that on earnings. Such a levy would produce about $4 trillion over the next 10 years – a nice down payment on solving the long-term deficit problem.

But how about economic growth? The truth is that there is actually very little evidence to support the argument that high taxes on the rich slow growth. In the United States, per capita growth was much slower between 1980 and 2010 when top marginal tax rates were low than between 1950 and 1980 when rates were high. Internationally, growth and tax rates are not related among OECD countries.

The reason that very high marginal rates would not affect growth, according to Saez and co-authors, is that much of the income generating activity of the top 1 percent does not contribute to growth. On the other hand, the potential $4 trillion of tax revenues could be put to productive use. If it were simply used to reduce federal debt, it would increase investment and stimulate growth. If it were used to enhance education or repair dilapidated infrastructure, it would have an even larger pro-growth effect.

While the new research is certainly generating controversy, it does suggest that the tax debate should be broadened.  Dramatically higher tax rates on the top 1 percent would produce enormous revenues, improve the distribution of income, and most likely lead to greater economic growth.


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    • I would differ with you on the issue of high taxes being a moral issue. The moral issue is borrowing money without any expectation of repaying the dabt. Taxes are levid to pay for the benefits supplied buy goverenments and those who earn more are assesed more. A person earning $300k would not pay more than half of his income even if the rates I sugested (see above) were in force today. None of his income would be taxed at the 35% rate now in effect.

    • High tax rates are a moral issue. It is immoral for government to confiscate one half (or more) of someone’s hard earned income. I have worked with sales people who made a lot of money. They worked 18 hour days and weekends to make $300k and more. How is it “fair” for a government steal more than half of their income? Secondly, when a government increases taxes and revenue there is rarely a concomitant reduction in spending; usually spending is increased. I see income as a private property issue and people in the USA have a right to private property.

    • Most people in this country are living in total hypocrisy. They cry, “Too much government,” and “No more taxes.” And yet, they moan about the bad roads, slow response to disasters, and the need for better schools and recreational areas, environmental issues, lax border control, and on and on.
      This country needs more taxes. We need to pay for what we have and not borrow from anyone to finance our cost of living, especially our own children. Our elected officials attempt to satisfy everyone by handing carrots to those who shout the loudest, and the problem gets worse. The new federal budget proposes to spend more than a trillion dollars more per year than the expected annual revenue.
      When I see the rows and rows of Mac mansions and million dollar pleasure boats on both east, and west coastlines, and hear of the opulent salaries of some citizens, I know there is enough money to fund this country without borrowing from foreign countries. I don’t want to take from the rich and give to the poor, but, since wealth depends partly on birth and luck, those who are given much, much is expected!
      A flat tax is not an equitable way to asses taxes. The minimum wage worker earns about $11,000 per year and the minimum standard of living requires $10,600 per year. This worker is spending 100% of his money on basic necessities: food, housing, clothing, healthcare, etc. If he paid taxes, a basic necessity would suffer.
      The average worker earns about $40,000 per year and spends about 25% of his income on basic necessities. He could afford to pay some tax without shortchanging his standard of living. The top 1% earns over $3,000,000 per year and spends …….% on his basic necessities. If he were taxed at 90% on his income over $1,350,000, he would not shortchange his basic living needs and he would still amass enough wealth in one year to last a lifetime. Our tax code needs to include tax brackets at 50% of taxable income over $500,000, 65% of taxable income over $750,000, 80% of taxable income over $1,000,000, 90% of taxable income over $1,350,000 and eliminate and/or simplify the exemptions, credits, deferred benefits, and surcharges found in the tax code.
      From 1940 to 1963, the top tax rate was between 81% and 91%. During this time, the USA supported the baby boom population explosion, the rebuilding of Europe after World War 2, the trip to the moon, the massive interstate road system, and the increase in the standard of living for the most people in the history of the world.. By 1980, the top tax rate had fallen to 70% and is now 35% and the real wages of the middle class has remained mostly flat since then. The real wages of the wealthy have increased exponentially, and any infrastructure projects must be financed with borrowed money because the government is already deeply in debt. I admit that I am not very smart, but television, semi-conductors, microprocessors, computers, and cell phones came to wide use while the top tax rate was above 70%. Investment money was available for these innovations even though the pundits say that investment money comes from the very wealthy who would not support innovation if they were taxed above 35%. I find it hard to believe that investment money is needed from the very wealthy. If banks needed more money to loan, they would be paying more than the 1.7 to 2.5 percent interest on saving accounts and CD’s.
      If the above mentioned tax brackets were in place:
      1) The surcharges on compensation of CEO’s of TARP recipients being considered by the president and congress would be unnecessary.
      2) Top executives of all industries would no longer walk away with opulent salaries, bonuses, golden parachutes, deferred compensation, etc. These taxes would be used to fund the cost of our society.
      3) FOLLOW THE MONEY! The IRS would have much more incentive to investigate fraud if their portion was 90% instead of 35%. I wonder if Mr. Madoff could pull his scam for years if the IRS was extracting 90% of his taxable income from the start of his scam? FOLLOW THE MONEY! Al Capone was jailed because of income tax fraud.
      4) No new bureaucracy needs to be created. The IRS is fully capable of administering this added provision.

    • This article says that adding 4 trillion dollars in taxes is just a down payment on dealing with debt. The real drivers of debt are borrowing and spending too much. As long as these two factors are not addressed, it doesn’t really matter how much revenue you generate, you won’t close the gap unless you address these factors. Some groups estimate that government waste accounts for 200-400 billion a year if you include fraud, waste and abuse.

      Everything the government spends money on doesn’t provide the taxpayer with the best return. Medicare and SS are supposed to be self-funded programs, but the government is siphoning funds off to pay for other things. Given the way we operate, no amount of money will be enough to feed the dragon that borrows over 1 trillion dollars a year for things we don’t need. The reality is this. If the government gets more funds, it will simply waste more money.

      Instead of raising more taxes, how about getting rid programs that we don’t need, duplications in government services other things that result in borrowing over a trillion dollars a year. And one last thought. When the government gets involved in programs, the costs of those programs tend to rise. Look at education and medical care. I would love to see someone come up with what the extra costs are to the taxpayer as a results of having the government involved. Sounds like an unintended pseudo tax to me.

    • 50% pay no income tax already, it is about time these people started contributing and stop being a drain on society.

About Encore

  • Encore examines the changing nature of retirement, from new rules and guidelines for financial security to the shifting identities and priorities of today’s retirees. The blog also explores news that affects retirement, from the Wall Street Journal Digital Network and around the web. Lead bloggers are reporter Catey Hill and senior editor Jeremy Olshan. Other contributors include The Wall Street Journal’s retirement columnists Glenn Ruffenach and Anne Tergesen; the Director for the Center for Retirement Research at Boston College, Alicia Munnell; and the Director of Research for Pinnacle Advisory Group, Michael Kitces, CFP.