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.
READER COMMENTS
David Seltzer
Apr 4 2021 at 12:36pm
Given the Biden proposal, how are incentives to produce affected? Less capital investment, slower NGDP growth, slower employment increases? A marginal tax rate of 56.7% sounds like the edge Casinos have.
Garrett
Apr 9 2021 at 8:22am
I know an econlog blogger who would argue that NGDP growth will be determined by the Federal Reserve’s monetary policy decisions, but that the split between real growth and inflation will be due to real factors such as tax rates.
Alan Goldhammer
Apr 4 2021 at 1:43pm
This whole debate is mind-numbing. The focus ought to be on tax reform in the true sense. Get rid of all tax preferences, eliminate the corporate tax (it generates an increasingly smaller amount of money and is subject to easy tax avoidance by skillful accountants) or move it to a very low level say 5%, institute a VAT which is near to impossible to avoid. By streamlining the tax code, one doesn’t need to worry about the poor state of the IRS enforcement staff as they would likely not be needed much going forward as all audits could be done electronically.
Lizard Man
Apr 5 2021 at 2:36am
“move it to a very low level say 5%, institute a VAT which is near to impossible to avoid. By streamlining the tax code, one doesn’t need to worry about the poor state of the IRS enforcement staff as they would likely not be needed much going forward as all audits could be done electronically.”
I really like this comment. I think far too little attention is devoted to making government laws and regulations that are enforceable with a minimal amount of effort and hence actually predictable enforced.
robc
Apr 6 2021 at 9:36am
Single Land Tax.
Zero deadweight loss. Anything else is just moving the problem around.
I agree on the corporate income tax. Get rid of it and require profitable companies to pay a certain percentage of profits as dividend. As long as we have an individual income tax that prevents the corporation from being entirely a tax dodge. Dividends have other advantages too.
VAT is bad because it is hidden. Taxes should be obvious. Withholding has the same issue. Any income tax should require the taxpayer to write a monthly (or annual!) check*.
*yes, I realize few would do that, for most people it would just be set up as an auto-withdrawal on your checking account like paying utilities. But it would still go into and come out of the checking account, so would be felt.
Thomas Lee Hutcheson
Apr 4 2021 at 9:57pm
But how much is the deadweight loss that increases by 10%?
Compared to what other tax or increase in the deficit?
Considering the differences between effective tax rates on different corporations, there is significant DWL from increasing taxes on corporate “income,” so it would be preferable that the full increase in taxes be in the form of personal income tax (or progressive consumption tax).
Mallika Bachan
Apr 5 2021 at 4:25am
I didn’t get this. Why, if the Federal marginal tax rate is increasing by 2.6%, would his rate increase by 4.8%? And I saw you said dead weight loss is proportional to the square, but I am unclear what are you squaring, to get 9.6?
David Henderson
Apr 6 2021 at 9:27am
Mallika,
See my blog post from yesterday. It answers everything you asked.
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