Raising the Top Marginal Income Tax Rate to 70 Percent Is Misguided, To Say the Least

Freshman congressional representative Alexandria Ocasio-Cortez (D-NY) has been making headlines over the past week by advocating for a 70 percent marginal tax rate to fund her Green New Deal. The idea is that the richest of citizens pay a higher tax rate in order to fund Ocasio-Cortez's plan to fight climate change. The argument goes beyond the "rich should pay their fair share" narrative that is so common on the Left.

Those who are supportive of Ocasio-Cortez's plan, such as Matthew Yglesias and Paul Krugman, that go as far as arguing that a) this was done in the 1950s, and it was fine, and b) that 70 percent is economically a reasonable amount. Presenting it this way makes it look uncontroversial and unprecedented. As I will point out, neither one of these is true. I am not going to touch on the finer policy points of the Green New Deal (e.g., we probably won't reach 100 percent renewable energy by 2059 [Clack et al., 2017], much less than Ocasio-Cortez's proposed 2030) because that it is a separate conversation. What I would like to do is walk through and scrutinize the arguments used for such a tax increase.

What Is a Marginal Tax Rate?
I feel like providing an overview of what a marginal tax rate because I felt like that got lost in some of the news coverage. As the American Enterprise Institute covered, certain prominent figures on the Right botched up. House Minority Whip Steve Scalise (R-LA) said that Ocasio-Cortez's plan was to "take away 70 percent of your income and give it to leftist fantasy programs." Grover Norquist, a longtime advocate for lower taxes, made a similar faux pas. A marginal tax rate is the tax rate incurred on an additional dollar of income.  The current top marginal tax rate is 37 percent. Using the current tax rates (see below), what that means is that any dollar above $510,300 for an unmarried individual is taxed at the 37 percent rate. The rest of the dollars are taxed based on the brackets (e.g., any income made below $9,700 is taxed at 10 percent, any income between $9,700 and $39,475 is taxed at 12 percent).

Source: Tax Foundation

If an unmarried individual were to make a million dollars under the current tax code, here is how it would work:

• $970 (10 percent of $9,700)
• $3,573 (12 percent of the next $29,775 [=$39,475-$9,700])
• $9,840 (22 percent of the next $44,725 [=$84,200-$39,475])
• $18,366 (24 of the next $76,275 [=$160,725-$84,200])
• $13,880 (32 percent of the next $43,375 [=$204,100-$160,725])
• $107,170 (35 percent of the next $306,200 [=$510,300-$204,100])
• $181,189 (37 percent of the remaining $489,700 [$1,000,000-$510,300])
• Grand Total in Taxes: $334,988

Because of the progressive nature of the marginal tax brackets, this hypothetical millionaire is taxed at a rate of 33.5 percent, not 37 percent. In this example, that's a difference of $35,012 (or 3.5 percent). The math is going to vary based on the brackets, but that is how marginal tax rates work. Now that we walked through the arithmetic, let's get into some economic history.

Economic History Concerning the Top Marginal Tax Rate
For proponents of a higher top marginal tax rate, they like to point to the 1950s as a heyday for when the top marginal tax rate was at its highest (see below). The argument continues to go that in spite of these high top marginal tax rates, the economy grew just fine.

Much like Scalise was disingenuous with his portrayal of what a marginal tax rate is, Krugman et al. are being disingenuous by presenting this as evidence. Why? They fail to distinguish between the statutory and effective tax rate. The statutory tax rate is the amount imposed by the laws, the one on the books. The effective tax rate is what individuals actually pay. Either through deductions, loopholes, or tax evasion, the effective tax rate was lower than the statutory rate. An economic paper written by those who are proponents of higher tax rates concede this point (Piketty et al., 2017), as is illustrated below. This goes to show that the "1 percent" are not facing a significantly lower income tax rate than they did at the peak in the 1950s.

Another stubborn fact is that regardless of what the top marginal tax rate has been, federal taxes as a percent of the GDP generally oscillated between 15 and 20 percent. Despite different tax brackets and general tax policy, a constant within American tax history post-WWII is that taxes do not remain above 18 percent of GDP for very long. History provides a worrisome precedent for Ocasio-Cortez because it shows that it is easier to raise the top marginal tax rate than it is to raise the amount of tax revenue the government receives.

Source: St. Louis Federal Reserve

On an international level, the top marginal income tax rate for the 26 OECD countries has dropped from 64 percent in 1980 to 47 percent in 2017 (Cato Institute; OECD). As will be explained shortly, the effects of globalization have made it less practical to have higher top marginal income tax rates.

Why a 70 Percent Top Marginal Tax Rate Would Not Work 
A deeper look at the historic data has shown that the United States did not live some fantasy in which tax rates led to a boost in tax revenue that allowed for wonderful economic growth. However, there is even more to the argument that Ocasio-Cortez, Krugman, and the rest of proponents of government largesse forget when considering this topic. Here is a list of a few of those considerations:

• We cannot duplicate the unique macroeconomic circumstances under which the 1950s economic prosperity occurred. The United States came out of a decade-plus economic downturn. Something tells me that we don't want to have a repeat of the Great Depression. The infrastructure of European nations was demolished in WWII, which gave the United States the upper hand post-WWII. The economy was more labor-intensive than it is now. Speaking of capital.....
• As the Cato Institute points out, there were major capital controls prior to the 1980s that kept money better contained in the United States. With more countries adopting flexible exchange rate systems (including the United States), industries are much more mobile, which means industries can more easily move their tax base away from the United States if tax rates become that onerous. 
• According to an economic paper from proponents of higher taxation, the optimal tax rate is 73 percent (Diamond and Saez, 2011). The issue with this optimal tax rate is that it is the combined rate, not simply the marginal tax rate. Assuming this is an optimal rate (more on that below), we would need to remove all loopholes and exemptions, which are cornerstones of the U.S. tax code. 
• The Diamond and Saez paper comes with some flaws, including not accounting for long-term impacts on the taxpayer (Mathur et al., 2012).
• Bernie Sanders and his colleagues like to use Denmark as an example of a socialist utopia, but what they don't realize is that the Nordic countries do not just tax the "1 percent" at those high rates. They tax everyone at those high rates, including the poor. 
• If you look at Gallup polling, 93 percent of Americans consider the amount they pay for income tax to be "too high" or "just right." If the Far Left were honest about what it would take to pay not just for the Green New Deal, but also Medicare for All and its other pet projects, they would come out and say that everyone (not just the "one percent") needs to pay significantly higher tax rates. Something tells me that their ideas would not have the same level of popularity if the working class American knew that the higher tax rates would also apply to him or her. 
• An optimal tax rate is as much about political philosophy as it is efficiency, as a study from economists Jon Gruber and Emanuel Saez shows (see Table 9 of Gruber and Saez, 2000). 73 percent is optimal....if you want a utilitarian, progressive policy in the vein of Rawlsian thought. If you want something more conservative, lower the amount to 30 percent. If you want no wealth redistribution, the optimal tax rate is 3 percent. 
• Stanford economist Chad Jones argues that when you factor in entrepreneurs' contributions to society (e.g., Uber, Amazon), the social welfare gains reduce the optimal tax rate to 28 percent. 

Quick Side Note on Economic Effects of Taxes

Getting into how lower taxes could be part of the solution is too much for this blog entry since we have already covered so much ground already. What I would like to point out today is that onerously high marginal tax rates have adverse effects, such as stifling innovation (Akcigit et al., 2018), reducing income mobility (Alloza, 2018), and reducing economic growth (see literature review from Tax Foundation). 

Postscript: There was not a time during the United States' history in which high marginal tax rates translated into greater economic productivity. In the 1950s, the Top One Percent did not actually pay anywhere near the 90 percent amount. Even if they had, there would be no way to replicate the extraordinary conditions in which the economic productivity of the 1950s was created. There already is an admission from Matthew Yglesias that the Green New Deal would not rely on marginal tax rate revenue, but rather from deficit spending, which makes a marginal tax increase less useful given its failure to substantially increase tax revenue in the past. 

The burden of proof is on Ocasio-Cortez and the economists who support such a high top marginal tax rate that this would be a good policy idea. Proponents need to illustrate how this tax increase would substantially increase tax revenue, even though it has not done so in the past. Proponents would need to show how these tax increases wouldn't hamper economic growth or hurt both rich Americans and everyday working Americans alike. While Ocasio-Cortez's proposal has made for an interesting academic debate, I don't think such a proposal could meet such a burden of proof, nor do I see it becoming a reality in the United States anytime soon.


1-15-2019 Addendum: The Tax Foundation put out a preliminary estimate of Ocasio-Cortez's suggestion. It would do anything from generating $189 billion to losing $63.5 billion in tax revenue over the next decade. Even if we went with Washington Post's rosier estimate of $700 billion, it is a safe bet it would not cover the costs of Ocasio-Cortez's Green New Deal.

1-16-2019 Addendum: The University of Chicago forum of expert economists found that 49 percent of economists do not agree that a 70 percent marginal tax rate could raise revenue significantly without harming the economy. With weighted responses, that increases to 63 percent.