Tag: marginal tax rates

Why Does Alexandria Ocasio-Cortez Support a 70% Top Marginal Tax Rate? What Psychology Says About How Envy and Compassion Motivate Tax Preferences

This month, the newly minted Democratic Congresswomen from New York, Alexandria Ocasio-Cortez (D-NY) suggested levying a 70% tax rate on the rich. After stagflation in 1970s, many had assumed we’d reached a consensus that extraordinarily high marginal tax rates are unsustainable. So why do these ideas keep popping up? Social psychology may help explain why. A recent academic study finds that support for redistribution by taxing the rich to give to the poor is likely driven by several psychological motives including not only compassion but also envy.

In an interview with Anderson Cooper on 60 Minutes Rep. Ocasio-Cortez explained:

You know, it— you look at our tax rates back in the ’60s and when you have a progressive tax rate system. Your tax rate, you know, let’s say, from zero to $75,000 may be ten percent or 15 percent, et cetera. But once you get to, like, the tippy tops—on your 10 millionth dollar— sometimes you see tax rates as high as 60 or 70 percent. That doesn’t mean all $10 million are taxed at an extremely high rate, but it means that as you climb up this ladder you should be contributing more.

Rep. Ocasio-Cortez says the money would be spent on the “Green New Deal” to end use of fossil fuels within 12 years. This would be an ambitious goal, particularly since about 80% of the energy we all currently use in the U.S. comes from fossil fuels. Raised revenue could also go toward her proposal for government-supported health care, and government-paid college. Paul Krugman blessed the idea with his New York Times piece, “The Economics of Soaking the Rich,” saying he believed such a high rate was “optimal.”

What motivates these beliefs of “Soaking the Rich”? Of course, no one can know with certainty what are Rep. Ocasio-Cortez’ true motivations. However, social psychologists in “Support for redistribution is shaped by compassion, envy, and self-interest, but not a taste for fairness,” investigate broadly what motivates people to support income redistribution. In short, they find that envy, compassion, and self-interest drive support for high taxes on the rich. Notably, they find that people who are compassionate are significantly more likely to support redistribution and give charitably. However, envious people support income redistribution but are not more likely to give charitably. This suggests that one way to know if a person’s desire to soak the rich is due to altruism or resentment is to find out if they choose to volunteer or give charitably in their private lives.

The researchers measured support for income redistribution using agreement with statements like “wealth should be taken from the rich and given to the poor” and “the government should increase taxes to give more help to the poor” and “inequality in the distribution of wealth is unjust.” Participant answers to these questions were averaged together to create an average preference for redistribution.

Why All the Labor Force Dropouts?

The distinguished Stanford University economist Robert Hall, co-architect of the famed Hall-Rabushka flat tax, once described himself to me as a [Bill] Clinton Democrat. Bob Hall wrote one of the most serious studies trying to figure out why the U.S. economy has remained so weak for so long. He concluded that much of the explanation lies in the ways in which recent marginal tax and transfer incentives discourage work.

In an analysis similar to that of Casey Mulligan of the University of Chicago, Hall attributes much of the startling drop in labor force participation to the expansion of federal transfer payments. Disability benefits and food stamps, in particular, are quickly phased-out if nonworkers take a job, or part-time workers switch to full-time work, or single-earner families become two-earner families. In other words, higher tax rates on work and more generous subsidies to leisure leave the economy with fewer people seeking work and therefore less production, lower tax revenue and greater federal spending on transfers from those who earn income to those who instead rely on government.

As Hall put it,

Labor-force participation fell substantially after the crisis, contributing 2.5 percentage points to the shortfall in output. The decline showed no sign of reverting as of 2013. Part is demographic and will stabilize, and part reflects low job-finding rates, which should return to normal slowly. But an important part may be related to the large growth in beneficiaries of disability and food-stamp programs. Bulges in their enrollments appear to be highly persistent. Both programs place high taxes on earnings [emphasis added] and so discourage labor-force participation among beneficiaries. The bulge in program dependence …  may impede output and employment growth for some years into the future.

More Evidence That Lower Marginal Tax Rates Speed Up Economic Growth

An important and timely paper from Columbia University economist Karl Mertens finds that amount of income reported on tax returns is highly sensitive to marginal tax rates, and that the effect is mainly from changes in real activity not tax avoidance.

Mertens estimates “elasticities of taxable income of around 1.2 based on time series from 1946 to 2012. Elasticities are larger in the top 1% of the income distribution but are also positive and statistically significant for other income groups… . Marginal rate cuts lead to increases in real GDP and declines in unemployment.”  Other recent research also shows that “higher marginal tax rates reduce income mobility” while eliminating higher tax brackets improves upward mobility.

Both Democratic candidates for the presidency, Sanders and Clinton, want to greatly increase marginal tax rates on high incomes and on realized capital gains. By contrast, all Republican candidates propose to reduce marginal tax rates.

Mertens’ research unambiguously predicets that economic growth would slow or stop under the Democrats’ proposed tax increases, but accelerate under Republicans’ tax reforms.

Words I Don’t Say Very Often: ‘I Applaud Senate Republicans’

Much to my surprise, Senate Republicans held firm earlier today and blocked President Obama’s soak-the-rich proposal to raise tax rates next year on investors, entrepreneurs and small business owners.

I fully expected that GOPers would fold on this issue several months ago because Democrats were using the class-warfare argument that Republicans were holding the middle class hostage in order to protect “millionaires and billionaires.” Republicans usually have a hard time fighting back against such demagoguery, and I was especially pessimistic since every Republican senator had to stay united to block Senate Democrats from pushing through Obama’s plan for higher tax rates on the so-called rich.

But the GOP surprised me earlier this year with their united opposition to higher taxes, and they stayed strong again today in blocking a bill that would raise tax rates on upper-income taxpayers. Here’s an excerpt from the New York Times.

Republicans voted unanimously against the House-passed bill, and they were joined by four Democrats — Senators Russ Feingold of Wisconsin, Joe Manchin III of West Virginia, Ben Nelson of Nebraska, and Jim Webb of Virginia — as well as by Senator Joseph I. Lieberman, independent of Connecticut. “You don’t raise taxes if your ultimate goal, if the main thing is to create jobs,” said Senator John Thune, Republican of South Dakota, echoing an argument made repeatedly by his colleagues during the floor debate. The Senate on Saturday also rejected an alternative proposal, championed by Senator Charles E. Schumer of New York, to raise the threshold at which the tax breaks would expire to $1 million. Some Democrats said that the Republicans’ opposition to that plan showed them to be siding with “millionaires and billionaires” over the middle class.

Not only did GOPers stand firm, but they were joined by five other senators (including four that have to face the voters in 2012). This presumably means Democrats will now have to compromise and agree to a plan to extend all of the 2001 and 2003 tax cuts.

At the risk of being a Pollyanna, I wonder if the politics of hate and envy is falling out of fashion. Obama’s plan for higher tax rates hopefully is now dead, but that’s just one positive indicator. It’s also interesting that both of the big “deficit reduction” plans recently unveiled, the President’s Fiscal Commission and the Domenici-Rivlin Debt Reduction Task Force Report, endorsed lower marginal tax rates - including lower tax rates for those evil rich people. Both proposals also included lots of tax increases, so the overall tax burden would be significantly higher under both plans, but it is remarkable that the beltway insiders who dominated the two panels understood the destructive impact of class-warfare tax rates. Maybe they watched this video.

There Ain’t No Such Thing as a Tax Expenditure

The co-chairs of President Obama’s Fiscal Commission propose to eliminate several tax loopholes while reducing marginal rates.  Hear, hear.  But they describe those loopholes as “backdoor spending in the tax code.”  It is incorrect and dangerous to equate tax loopholes with government spending.

The tax code’s countless credits, deductions, and exclusions let people keep a portion of their earnings, provided they use the money how the government wants them to use it.  Tax loopholes therefore have a lot in common with government spending: they give power to politicians, inhibit freedom, reduce economic output, unjustly enrich special-interest groups, et cetera.

But to call them “tax expenditures” or “tax subsidies” or ”backdoor spending in the tax code” is to claim that when the government fails to take a dollar from you, it is spending that dollar.  It implies that your dollar actually belongs to the government, which is graciously letting you keep it.  And it implies that eliminating a tax loophole is not a tax increase, because that dollar already belonged to the government anyway.  The government has simply decided to spend its money somewhere else.

When you hear a politician use the terms tax expenditure, tax subsidy, or backdoor spending in the tax code, beware.  He’s about to raise your taxes.

Obama’s Plan to Raise Tax Rates

President Obama wants to raise the top two individual income tax rates for 2011. The top rates will rise from 33% to 36% and from 35% to 39.6%, unless the president and Congress agree to extend the current rate structure.

Before taking action on this issue, policymakers should consider the following facts and data. (All information is cited in my related congressional testimony).

  • President Bush cut the top federal tax rate by 5 percentage points, but the average top rate in the 30 OECD nations has also fallen by 5 percentage points since 2000.
  • Unless policymakers extend current tax relief, the combined U.S. federal-state top rate will increase from 41.9% to about 46.5%, based on OECD data. That will give us about the tenth highest rate among the 30 OECD nations.
  • The chart shows that the average top OECD rate fell from 46.7% in 2000 to 41.5% in 2009. If we let the Bush tax cuts expire, we won’t be simply going back to our situation in 2000—the world has changed since then as other countries have adopted more competitive tax rates.

  • President Obama’s proposed top federal rate of 39.6 percent is 41-percent higher than the 28-percent top income rate achieved in the late 1980s after the bipartisan Tax Reform Act of 1986.
  • Higher marginal tax rates will reduce incentives for working, investing, and expanding businesses, and they will increase incentives for tax avoidance and evasion.
  • If income tax rates rise, some high-income workers will work fewer hours and retire earlier. Some spouses in two-earner families will stay out of the workforce. Some angel investors will have less cash to invest in start-up ventures. And some small businesses will decide not to buy new equipment or hire new workers.
  • Higher-income taxpayers often have a lot of flexibility on their working and investing decisions—tax them more and they will reduce their reported income alot. Robert Carroll finds that this effect of raising the top rate from 35% to 40% would offset about 40 percent of the government’s otherwise expected revenue gain.
  • Today’s highest-earners are generally not passive inheritors of wealth, but are usually self-made and entrepreneurial. Glenn Hubbard notes, “when you look at data, you see that people who are rich almost entirely are rich because of entrepreneurial risk taking.”
  • Many people with high incomes are angel investors, who help to fuel small business expansion. If their taxes go up, they will have less money and fewer incentives to invest, and they will park more of their money in tax-free municipal bonds.
  • More than half of all business income in the United States is reported on individual returns, not corporate returns. This income is reported by proprietorships, partnerships, LLCs, and S corporations. If the top two individual income tax rates are increased, it would hit a substantial amount of this business income.
  • Robert Carroll looked at individual tax filers who derived more than half of their income from a business. He found that one-quarter of these taxpayers were in the top two tax rate brackets, and thus would be hit by the proposed tax increases.
  • The Joint Committee on Taxation found that about 25 million individual tax returns will report about $1 trillion of net positive business income in 2011. Of that total, 44 percent is in the top two income tax brackets and thus would be hit by the proposed tax increase.
  • In an empirical study, Glenn Hubbard and William Gentry found that higher marginal tax rates discourage entry into self-employment and business ownership. A study by Donald Bruce and Tami Gurley for the SBA similarly found that marginal tax rates affect entrepreneurship.
  • Once a small business is up and running, empirical research by Robert Carroll, Douglas Holtz-Eakin, Mark Rider, and Harvey Rosen found that higher individual income tax rates negatively affect hiring, investment, and expansion.
     

Those are the facts, and here are my views. It’s very sad that a nation that has been a bastion of free market growth and individual achievement has a tax code that is becoming very hostile to high-earners, entrepreneurs, and businesses.

Let’s keep the Bush tax cuts, cut our corporate tax rate from 40% to 20%, and cut government spending. Rather than the government filling its coffers at the expense of families, that policy would make the economy boom, and fill government coffers as a side effect of rising family incomes.

A Debate Between John F. Kennedy and Barack Obama

Here’s a clever video produced by the Winston Group, comparing the tax policies of two Democratic Presidents. Having previously highlighted Kennedy’s tax-cutting approach, it is painful for me to observe the class warfare approach of the Obama Administration.
 

What’s especially fascinating is that JFK intuitively understood the Laffer Curve, particularly the insight that deficits usually are the result of slow growth, not the cause of slow growth.