Optimal Top Tax Rates: A Review and Critique
Economists who advocate for more aggressively redistributionist tax policies argue that income tax rates of 73–83 percent for top earners would be “socially optimal,” in the sense of maximizing the tax revenue available for political redistribution. This article offers a systematic critique of these arguments, their assumptions, data, and methods. In examining the differences between an “optimal” tax rate for maximizing government revenue and an “optimal” rate for maximizing economic productivity, it finds a correlation between lower tax rates, higher GDP, lower unemployment, and increased social welfare.
This article also critiques the selective (and arguably low) estimates of the “elasticity of taxable income” (ETI) that many progressive tax advocates use to calculate optimal top tax rates. ETI measures how much reported taxable income levels shift in response to major tax changes: if ETI is “high,” individuals might report dramatically lower incomes following substantial tax increases and report higher incomes if taxes go down. Progressive tax advocates claim that the ETI for top earners is far lower than what either academic literature, recent history, or even their own methodological assumptions would suggest. Most also fail to consider how their tax proposals would affect the long-term dynamics of economic growth, including incentives for human capital and innovation. This article concludes that higher marginal tax rates would penalize the rewards of education, innovation, and investment in human capital. Because such policies would erode the dynamic long-term growth of our economy, they could neither maximize revenue nor enhance social welfare.