Is A 70% Tax Rate On Incomes Beyond A Million Dollars Enough? Why Not Back To 90 Where It Used To Be Before 1963?

The weekend Paul Krugman was on fire after Republicans cluelessly went on the warpath against Alexandria Cortez again, this time because of her 60 Minutes tax hike for the rich proposal. His NY Times column, The Economics of Soaking the Rich, started by asking "What does Alexandria Ocasio-Cortez know about tax policy?" and then answering... "A lot."

I have no idea how well Alexandria Ocasio-Cortez will perform as a member of Congress. But her election is already serving a valuable purpose. You see, the mere thought of having a young, articulate, telegenic nonwhite woman serve is driving many on the right mad-- and in their madness they’re inadvertently revealing their true selves.

Some of the revelations are cultural: The hysteria over a video of AOC dancing in college says volumes, not about her, but about the hysterics. But in some ways the more important revelations are intellectual: The right’s denunciation of AOC’s “insane” policy ideas serves as a very good reminder of who is actually insane.

The controversy of the moment involves AOC’s advocacy of a tax rate of 70-80 percent on very high incomes, which is obviously crazy, right? I mean, who thinks that makes sense? Only ignorant people like … um, Peter Diamond, Nobel laureate in economics and arguably the world’s leading expert on public finance (although Republicans blocked him from an appointment to the Federal Reserve Board with claims that he was unqualified. Really.) And it’s a policy nobody has every implemented, aside from … the United States, for 35 years after World War II-- including the most successful period of economic growth in our history.



To be more specific, Diamond, in work with Emmanuel Saez-- one of our leading experts on inequality-- estimated the optimal top tax rate to be 73 percent. Some put it higher: Christina Romer, top macroeconomist and former head of President Obama’s Council of Economic Advisers, estimates it at more than 80 percent.

Where do these numbers come from? Underlying the Diamond-Saez analysis are two propositions: Diminishing marginal utility and competitive markets.

Diminishing marginal utility is the common-sense notion that an extra dollar is worth a lot less in satisfaction to people with very high incomes than to those with low incomes. Give a family with an annual income of $20,000 an extra $1,000 and it will make a big difference to their lives. Give a guy who makes $1 million an extra thousand and he’ll barely notice it.

What this implies for economic policy is that we shouldn’t care what a policy does to the incomes of the very rich. A policy that makes the rich a bit poorer will affect only a handful of people, and will barely affect their life satisfaction, since they will still be able to buy whatever they want.

So why not tax them at 100 percent? The answer is that this would eliminate any incentive to do whatever it is they do to earn that much money, which would hurt the economy. In other words, tax policy toward the rich should have nothing to do with the interests of the rich, per se, but should only be concerned with how incentive effects change the behavior of the rich, and how this affects the rest of the population.

But here’s where competitive markets come in. In a perfectly competitive economy, with no monopoly power or other distortions-- which is the kind of economy conservatives want us to believe we have-- everyone gets paid his or her marginal product. That is, if you get paid $1000 an hour, it’s because each extra hour you work adds $1000 worth to the economy’s output.

In that case, however, why do we care how hard the rich work? If a rich man works an extra hour, adding $1000 to the economy, but gets paid $1000 for his efforts, the combined income of everyone else doesn’t change, does it? Ah, but it does-- because he pays taxes on that extra $1000. So the social benefit from getting high-income individuals to work a bit harder is the tax revenue generated by that extra effort-- and conversely the cost of their working less is the reduction in the taxes they pay.

Or to put it a bit more succinctly, when taxing the rich, all we should care about is how much revenue we raise. The optimal tax rate on people with very high incomes is the rate that raises the maximum possible revenue.

And that’s something we can estimate, given evidence on how responsive the pre-tax income of the wealthy actually is to tax rates. As I said, Diamond and Saez put the optimal rate at 73 percent, Romer at over 80 percent-- which is consistent with what AOC said.

An aside: What if we take into account the reality that markets aren’t perfectly competitive, that there’s a lot of monopoly power out there? The answer is that this almost surely makes the case for even higher tax rates, since high-income people presumably get a lot of those monopoly rents.

So AOC, far from showing her craziness, is fully in line with serious economic research. (I hear that she’s been talking to some very good economists.) Her critics, on the other hand, do indeed have crazy policy ideas-- and tax policy is at the heart of the crazy.

You see, Republicans almost universally advocate low taxes on the wealthy, based on the claim that tax cuts at the top will have huge beneficial effects on the economy. This claim rests on research by … well, nobody. There isn’t any body of serious work supporting G.O.P. tax ideas, because the evidence is overwhelmingly against those ideas.

Look at the history of top marginal income tax rates (left) versus growth in real GDP per capita (right, measured over 10 years, to smooth out short-run fluctuations.):

What we see is that America used to have very high tax rates on the rich-- higher even than those AOC is proposing-- and did just fine. Since then tax rates have come way down, and if anything the economy has done less well.

Why do Republicans adhere to a tax theory that has no support from nonpartisan economists and is refuted by all available data? Well, ask who benefits from low taxes on the rich, and it’s obvious.

And because the party’s coffers demand adherence to nonsense economics, the party prefers “economists” who are obvious frauds and can’t even fake their numbers effectively.

Which brings me back to AOC, and the constant effort to portray her as flaky and ignorant. Well, on the tax issue she’s just saying what good economists say; and she definitely knows more economics than almost everyone in the G.O.P. caucus, not least because she doesn’t “know” things that aren’t true.

And Krugman's not alone here. Eric Levitz called her 70% top tax rate both moderate and evidence-based policy. He began by reminding his readers that when Reagan took office, affluent Americans paid 70% on all income above $216,000. "In the decades since," he wrote, "our country’s highest earners have seen their annual pay skyrocket, while the median household’s has barely budged. As a result, America’s 160,000 richest families now lay claim to 90% of its wealth. Studies suggest that this kind of inequality erodes social trust, abets plutocracy, and depresses economic growth. Politicians from both major parties routinely suggest that they see inequality as a major problem.

The case for trickle-down economics-- which is to say, the idea that high top-marginal tax rates hurt economic growth-- is much weaker now than it was in 1980. The U.S. saw faster GDP and productivity growth in the decades before Reagan’s tax cuts, than it did in the decades after. And during that latter era, the American economy grew at roughly the same rate as peer nations with higher top tax rates. A separate premise of the trickle-down theory held that raising taxes on the rich eventually costs the government revenue by discouraging work. The latest economic research suggests that this is true-- but only if you raise the top tax rate higher than (approximately) 70 percent.

Meanwhile, French economist Thomas Piketty has demonstrated that high tax rates reduce pre-tax inequality-- ostensibly, by discouraging rent-seeking among top executives, whose compensation is often determined less by productivity than a combination of social mores and their own audacity: CEOs are less likely to extract an extra $5 million from their companies (instead of allowing their firms to invest that sum in other purposes) if they know that Uncle Sam will collect 70 percent of their bonus. Thus, there is now some reason to believe that confiscatory top rates can reduce wage inequality, while producing some gains in economic efficiency.

All of which is to say: In 1980, taxing incomes above $216,000 (or $658,213 in today’s dollars) at 70 percent was considered a moderate, mainstream idea, even though wage inequality was much less severe, and supply-side economics had yet to be discredited.

...There is nothing substantively extreme about Ocasio-Cortez’s proposal. It is true that, when the top marginal rate was last at 70 percent, there were more loopholes in the tax code enabling the affluent to sneak out of that top bracket. But this does not mean that Ocasio-Cortez’s tax policy would actually be more radical than Jimmy Carter’s was-- after all, the congresswoman’s 70 percent rate kicks in at a much higher threshold, exclusively targeting America’s super-rich (who weren’t nearly as well off in the 1970s as they are now). One can raise a variety of technocratic quibbles with Ocasio-Cortez’s plan (raising taxes on capital gains might be a more effective way of soaking the super-rich; a confiscatory top marginal rate might prove impotent absent a global war on tax havens). But it would not be extreme in its redistributive implications, relative to our country’s past tax practices, or to other nations’ current ones. And a significant number of highly respected economists have endorsed top tax rates roughly as high as the one floated by the congresswoman, while Piketty has advocated for an 80 percent top rate.

Meanwhile, in terms of public opinion, Ocasio-Cortez’s view on tax policy for the rich is much more mainstream than Susan Collins’s.

Last year, a Data For Progress and YouGov Blue poll asked voters if they would support a 90 percent tax rate on all income above $1 million. Respondents opposed the idea by (just) a two-point margin. In Pew Research polling taken shortly before Congress passed the Trump tax cuts, voters opposed cutting taxes on households that earn more than $250,000 by a 48-point margin.

The notion that confiscatory tax rates on super-high incomes are more popular than the Republican Party’s alternative is buttressed by other data. For example, when Berkley political scientists David Broockman and Douglas Ahler offered voters seven different tax-policy options (ranging from extremely conservative to extremely progressive) in 2014, they found that the furthest left option-- establishing a maximum annual income of $1 million (by taxing all income above that at 100 percent)-- was the third-most-common choice, boasting four times more support than the Republican Party’s 2012 platform on taxation.

And yet, the fact that Susan Collins voted to sharply cut taxes on the rich in 2017 has not led nonpartisan news outlets to describe her as a far-right extremist. In fact, just yesterday, the New York Times referred to her as one of the Senate’s “most moderate members.” (Which is enough to make one wonder whether the overrepresentation of the affluent among national reporters-- and the extremely rich, among owners of national media companies-- might bias our political discourse in the upper class’s favor.)

Wonder, wonder, wonder... I say yes, it does! And Susan Collins is a damn fool in any case.

The Trump Economy Exposed

Americans have been noticing-- in increasing numbers-- that the Republican tax cuts have done exactly what they were designed to do: make the rich richer. And nothing more. Trump's economic miracle is an economic mirage, with the GOP's chief marketer "pulling numbers out of thin air when it comes to the economy, jobs and the deficit."

Last month Jay Willis, writing for GQ, warned that the "tax cuts for the rich aren't helping anyone but the rich. When the Democrats label the Ryan/Trump tax cuts a "scam," they were exactly right. "The tax reform bill is, as expected, a giant reverse Robin Hood scam that delivers on none of the Republican Party's loftiest promises. Six months after the bill's enactment, real wages are down slightly and appear to be getting worse, says economist Noah Smith at Bloomberg, whose charts on the subject feature titles like 'Not Very Convincing,' 'That's Not Very Pretty,' and 'Very Meh.' While business investment is up slightly, the increase isn't notable compared to those observed in previous years. The Tax Cuts and Jobs Act, Smith concludes, is not going to pay for itself, as Ryan and company asserted that it would-- a failure, he adds, which suggests that the decades-old practice of slashing taxes to jump-start economic growth has reached the outer limits of its alleged efficacy, and should be retired for good."

But the Trump Regime did what it's been promising to do: unilaterally redefine the tax code to give the very wealthiest Americans another huge tax break. "Last year's massive tax cut bill," wrote Erik Sherman, "was supposed to increase economic activity to such a degree that everyone would be better off and more resulting taxes would fill the treasury. Instead, the deficit is increasing because increases in spending continue to outpace revenues. Republicans knew there was a problem-- just like everyone else did, no matter who claimed what. With the way budget rules work in the Senate, Congress technically had to restrict growth of deficits past a ten-year window. A large break for pass-through income affected the self-employment and many small businesses. There were exclusions. But new rules from the IRS, otherwise known as part of the Trump administration's Treasury Department, have provided loopholes for some of the largest businesses and wealthiest people in the country, first noticed by investigative reporter David Sirota in the areas of banking, but apparently extending to other industries as well."

Many small businesses and self-employed individuals use pass-through structures so that profits pass through directly to the owners rather than being taxed once at the corporate level and again for the individual. The rationale was that the businesses were essentially personal.

These pass-through structures also worked for many wealthy people who used the strategies to reduce their taxation as well.

The new tax law enabled pass-through businesses to deduct 20% of their gross income. As part of limiting deficit growth, at least on paper, Congress exempted certain "specified service trade or business" entities (SSTBs), subject to certain threshold amounts of income. Businesses that appeared on the unqualified list included the following:

(A) any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees,
(B) any banking, insurance, financing, leasing, investing, or similar business,
(C) any farming business (including the business of raising or harvesting trees),
(D) any business involving the production or extraction of products of a character with respect to which a deduction is allowable under section 613 or 613A, and
(E) any business of operating a hotel, motel, restaurant, or similar business.

That left out some lucrative opportunities where companies and wealthier people would not get breaks. The IRS has fixed that "oversight."

...Here is the new rule definition that rationalizes the change:

Commenters requested guidance as to whether financial services includes banking. These commenters noted that section 1202(e)(3)(A) includes the term financial services, but that banking in separately listed in section 1202(e)(3)(B) which suggests that banking is not included as part of financial services in section 1202(e)(3)(A). The Treasury Department and the IRS agree with such commenters that this suggests that financial services should be more narrowly interpreted here. Therefore, proposed §1.199A-5(b)(2)(ix) limits the definition of financial services to services typically performed by financial advisors and investment bankers and provides that the field of financial services includes the provision of financial services to clients including managing wealth, advising clients with respect to finances, developing, retirement plans, developing wealth transition plans, the provision of advisory and other similar services regarding valuations, mergers, acquisitions, dispositions, restructurings (including in title 11 or similar cases), and raising financial capital by underwriting, or acting as the client’s agent in the issuance of securities, and similar services. This includes services provided by financial advisors, investment bankers, wealth planners, and retirement advisors and other similar professionals, but does not include taking deposits or making loans.

It was the banking industry that pushed for this and nearly 2,000 banks are organized as pass-through entities, according to the American Bankers Association.

Although not covered in that story, you might wonder how other industries were affected. Here are some of the other decisions:

• In the field of health, the Treasury has excused "the provision of services not directly related to a medical field, even though the services may purportedly relate to the health of the service recipient." That apparently includes companies that do payment processing for health-- in other words, massive insurance and benefits organizations-- and companies that make or sell pharmaceuticals or medical devices.
• In the performing arts, it is the artists who, again depending on income limits, are restricted for the additional deduction. Not so the those who operate the facilities in which performances happen or who broadcast or disseminate video or audio to the public. That means many production companies pulled together for particular projects or ongoing ones could get a big break.
• The IRS does say that the field of consulting "includes providing advice and counsel regarding advocacy with the intention of influencing decisions made by a government or governmental agency and all attempts to influence legislators and other government officials on behalf of a client by lobbyists and other similar professionals performing services in their capacity as such." Other services are not restricted. But that would seem to include many activities aimed at influencing the public, whether fake grassroots organizations (also known as astroturfing), deploying public media campaigns, or doing PR aimed at media organizations. Inducing pressure on the public will have an effect on government officials, but probably couldn't be called "advice and counsel" in this definition.
• Similar to the performing arts, athletes, coaches, team managers, and other individuals are part of the restricted groups. Not so people who own and operate stadiums or those who broadcast or disseminate video or audio to the public, leaving out media companies.
• Investing and investment management, which would normally be considered part of financial services and, no, ineligible for the additional tax break, doesn't include directly managing real property. Like real estate, the major business of Donald Trump, who operates through a large series of pass-through entities.

That growing deficit just got a good helping of fertilizer.

A New York Times editorial on Monday drove the point home: You Know Who The Tax Cuts Helped? Rich People. "When Republicans were pitching a massive tax cut for corporations and wealthy families last year, they promised voters many benefits: increased investment, higher wages and a tax cut that pays for itself. The tax plan, congressional leaders said, would turbocharge the American economy and provide a much-needed helping hand to working-class families. 'Most people, half the people in this country, live paycheck to paycheck, so there’s a lot of economic anxiety,' the House speaker, Paul Ryan, told The Times in November. 'And I think just one of the key solutions is faster economic growth, more jobs. And I think the best thing we could do to deliver that is tax reform.' So, more than six months since President Trump signed the tax cut into law, is it delivering on the promises Mr. Ryan and other leaders made?"

The most notable outcome of the tax law is one that few Republicans talked about: Companies are buying back their own stock-- a lot of it. Stock buybacks are expected to reach a record $1 trillion this year. After Congress reduced the top federal corporate tax rate from 35 percent to 21 percent, businesses are flush with cash. Lawmakers also let companies repatriate foreign earnings that they have been amassing at a rate of 15.5 percent for cash and 8 percent for other assets.

By spending a big chunk of their tax windfall on buying back shares, businesses are boosting demand for and, thus, the price of their stock. It is no wonder then that the S&P 500 stock index is trading near its high.

...Share buybacks have an understandable appeal to executives, many of whom are compensated with stock themselves, and to investors. But buybacks do little for workers, most of whom own little or no stock. It is not even clear that it is in the best long-term interest of companies when they could be using that money to expand or invest in technology that would make them more productive and profitable in the future.

And what happened to that promise of a big raise for workers? No sign of it yet.

The typical family would earn $3,000 to $7,000 more a year, the White House Council of Economic Advisers said. In fact, real wages are down, largely thanks to the rising price of oil, which has more than offset any modest increase in income.

Even ignoring inflation, wages are up only 2.7 percent over the last 12 months. Even with the unemployment rate at a low 3.9 percent, businesses are not offering higher pay yet.

The idea that the tax cuts were going to line workers’ pockets was always a mirage. Most people will enjoy only a modest and temporary tax cut-- families earning $25,00 or less will save on average just $60 on their federal tax this year, and those making between $48,600 and $86,100 will save $930, according to the Urban-Brookings Tax Policy Center. Families in the top 1 percent, on the other hand, will save an average of $51,140.

...Today, many Republicans seem to realize that the tax cut has become a political liability, which is why they aren’t talking about it ahead of the November election. Even they realize that it doesn’t do any of what they promised.

Maybe that has a little something to do with why, for the first time, Gallup found that Democrats have a more positive image of socialism than they do of capitalism. 57% have a positive attitude towards socialism and only 47% have a positive attitude towards capitalism. Among young Americans-- age 18-29-- 51% have a positive attitude towards socialism and 45% have a positive attitude towards capitalism, "12-point decline in young adults' positive views of capitalism in just the past two years and a marked shift since 2010, when 68% viewed it positively."

In his popular newsletter, Judd Legum, made a point about Trump's dysfunction economy that goes a long way towards tying this all together. "Unemployment is low. GDP growth is strong. But official government data released on Friday show that real wages for American workers have gone down over the last year. Nominal wages, the dollar amount workers see in their paychecks, have slowly crept up, increasing 2.7% between July 2017 and July 2018. But that has not kept up with inflation, which rose 2.9% over the same period. The economy is growing. Workers, however, are falling further behind. What," he asks, "gives?"

Declining wages have not prompted Trump or his advisers to rethink their economic policies. Instead, Trump has ignored the actual economic data and pretended that workers’ paychecks are increasing.

On Sunday, Trump tweeted that “[y]our paycheck is bigger,” adding that “our country is booming like never before.”

Trump’s tax cuts have not created wage increases for American workers. His promises were empty.

...Why do so many Americans think the deck is stacked against them? Because it is. America is getting richer. Profits are rising. But the benefits are flowing to fewer and fewer people.

...One culprit for stagnant and declining wages: employer-provided health care.

Health care costs have skyrocketed over the last few decades, and most American workers get their health insurance through their employers. Dramatically increasing health costs in an employer-based insurance system create a couple of dynamics that depress wages.

First, employers may be hesitant to increase wages, knowing that they made need to absorb unknown increases in health costs in the future. Second, employees may be more reluctant to move jobs, fearing that it will impact their health coverage and costs. Less mobile employees have less bargaining power because employers know that low wages are unlikely to result in their departure.

Health care costs are also driving income inequality because they don’t impact all workers in the same way. This is because “[h]ealth costs are a bigger share of total compensation for lower-wage workers, and so rising health costs hit their salaries the most.”

Since the late 1970s, labor unions in America have been decimated. In the 1950s, 1 in 3 workers belonged to a union. Today, it’s 1 in 20. This decreases bargaining power for workers and wages for non-union workers.

A 2016 study by the Economic Policy Institute found the decline in unionization “has contributed to substantial wage losses among workers who do not belong to a union.” If, for example, unionization in 2013 had been the same as in 1979, men who are not union members would have earned an average of $2703 more in annual salary.

Unions “set pay and benefits standards that nonunion employers follow.” When union membership is robust, “nonunion firms lift wages to prevent their employees from leaving for higher, union wages.”

...These are hard problems, but there are potential solutions.

If health care costs and the employer-based system are keeping wages low, the government could help rein in costs and make insurance less dependent on an individual’s current job. Obamacare began this process, but the Trump administration has been weakening it. We could go further-- everything from a public option to Medicare-for-all.

As worker power declines, the government could make it easier to create new unions by passing laws to allow card check or increase worker power through sectoral bargaining.

If businesses don’t invest to make their workers more productive, the government could make major investments in better infrastructure-- roads, bridges, basic research and development-- that could make all workers more productive.

Most of the policies of the current administration are heading in the opposite direction. Trump’s policies are increasing health costs and weakening unions. He claimed to be interested in infrastructure investment but hasn’t followed through.