The Case Against High Marginal Tax Rates
By David Henderson
President Biden will soon present his proposal for increasing income tax rates and tax rates on capital gains on high-income people. He also proposes to raise the corporate income tax rate to 28 percent from its current level of 21 percent. I would not be directly affected by the first two proposals: my income, though high, is much lower than the income to which the higher tax rates would apply and although I have substantial capital gains, they are almost all on stocks owned in IRA-type retirement accounts. When I pull them out, they will be taxed at normal income tax rates anyway, and so the current light treatment of capital gains doesn’t apply to my gains. I would be directly affected by the increase in the corporate income tax rate since over half of my retirement savings are in US stocks.
But unless it comes to fighting a bill of attainder directed at me (and so far, that hasn’t been a threat), I don’t judge government policy by its effect on me. I judge it in two main ways. First, is it fair? Second, will it have good effects on people’s economic well-being? Judged by both standards, all three tax increases fail.
These are the opening two paragraphs of my most recent article at Defining Ideas, “The Case Against High Marginal Tax Rates,” April 2, 2021.
In researching this article, I dug up some earlier items I had remembered from the 1982 Economic Report of the President:
In the late 1970s and early 1980s, even mainstream economists started paying more attention to the harm that high marginal tax rates did to economies. Two major factors caused their shift in attention. First, inflation from the mid-1960s to 1980 had put even middle-income people in tax brackets that had been designed for high-income people. According to the 1982 Economic Report of the President, a four-person family with the median income in 1980 faced a marginal federal income tax rate of 24 percent, up from 17 percent in 1965. For a four-person family with twice the median income, the marginal tax rate had risen from 22 percent to 43 percent! That caused more economists to pay attention. Second, a group of economists that included Arthur Laffer started arguing in the 1970s that increasing already-high marginal tax rates didn’t yield much revenue because those higher rates discouraged people from working and encouraged them to engage in tax avoidance: taking payment in non-taxed benefits rather than in money and buying more-expensive houses than otherwise to get the benefit of the mortgage interest deduction and the property tax deduction. This group of economists called themselves supply-side economists. Mainstream economists, skeptical of such claims, began to research the issues more carefully. Many actually concluded that the less-extreme supply-side claims had merit.
And note the deadweight loss estimates:
President Biden is likely to propose raising the top marginal federal income tax rate from its current 37 percent to 39.6 percent. Consider the effect on deadweight loss for a very high earner in the state with the highest state income tax rates: California. That earner, if self-employed, now faces a marginal tax rate of 54.1 percent, composed of the federal income tax rate of 37 percent, the state income tax rate of 13.3 percent, and the Medicare tax rate of 3.8 percent. With the federal income tax rate increase, he would face a 56.7 percent marginal tax rate. His rate would increase by 4.8 percent. But his deadweight loss would increase by 9.6 percent.
Read the whole thing.