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One often hears the claim that, “top marginal tax rates were once 90% and the US grew like gangbusters.” One may have also heard the expression, “the optimal top marginal tax rate is 70%.”

With regard to the first claim – let’s ignore the macroeconometric problems with making such assertions. We can also ignore the correlation does not equal causation club which stymies much conversation. A useful question to ask in response to such a claim is, “90% of what?” It’s surely a big difference, today, if we had 90% tax rates on any income over $100,000 as compared to any income over $10,000,000 per year. And this is still an oversimplification – on what kinds of income? Are these annual? Are they in conjunction with other types of taxes? You can imagine, for example, that even 90% tax rates on labor income over $2 million per year may not be very onerous at all, as little labor income over $2 million exists, but also because how brutal that top tax rate is depends on the other fees, fines, taxes, losses of deducations, benefits and credits, folks incur as their income increases. So, in the golden age of the 1950s, the right question to ask is at what point the “big hit” of 90% taxes really kicked in. At low levels of income? Was it easy to avoid? How high was the income level for that bracket as compared to average income? What share of earnings was in the form of capital versus labor back then? And so on. Such questions are rarely asked, less rarely offered up as answers in anticipation to those questions.

With regard to the second claim – it’s pretty frustrating to see the normative claim slipped into a purely positive description. “Optimal’ can ONLY be discussed in reference to something that is being optimized. Is it the purpose of a tax system to generate as much revenue as possible? I don’t think so. And furthermore, I cannot stand it when folks on the right invoke the Laffer curve in these tax discussions. Why? Because discussing the Laffer curve in a way that implies, “we might be on the right hand side of it” implies that the optimum is in fact the peak of the Laffer curve. I find this absurd. The goal of tax policy is NOT I contend to maximize revenues, it is to generate the “desired” revenues as fairly as possible with as little economic distortion as possible. When the folks are citing 70% optimal rates, I hardly believe that they mean what I just said. By the way, my question is not ultimately answerable in any reasonable fashion. It would be nice if folks admitted it.

Have a nice weekend.

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3 Responses to “Top Marginal Tax Rates, A Brief Note”

  1. Doug M says:

    In the Laffer curve model the optimum is somewhere left of the peak.
    Exactly, how far left cannot be determined.

  2. Harry says:

    “…not answerable in any reasonable way.” You can say that again, WC.

    Next to the IPCC Consensus Scientists are the bean counters in the Congressional Budget Office and the Council of Economic Advisors who attempt to predict the effects of changes in taxation, often to the nearest ten billion dollars, to enable our elected representatives to “pay for” a twenty-billion dollar earmark.
    What we do know is that paying people to dig holes and fill them up is wasteful, whereas cleaning waste out of the barn, while not productive in itself, is productive if it is plowed down.

  3. Jim Rose says:

    If the elasticity of taxable income reaches a mere 0.92, the current US top rate is optimal under the diamond and Saez regime set out recently in the journal of economic perspectives. If the elasticity numbers move, they may have to advocate lower taxes for the super-rich.

    Diamond and Saez past over the issue of optimal taxation of capital income being perhaps zero, or at least low, by referring to administrative issues at the capital-income boundary.

    Rawls was awake to the power of incentives and advocated progressive consumption taxes because these taxes taxed what people take out of the common store of goods rather than what he or she contributes. Also not addressed by Diamond and Saez.

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