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Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Monday, December 19, 2011

Ayers & Edlin: Don’t Tax the Rich. Tax Inequality Itself.

New York Times op-ed, Don’t Tax the Rich. Tax Inequality Itself, by Ian Ayres (Yale) & Aaron S. Edlin (UC-Berkeley):

What we call the Brandeis Ratio — the ratio of the average income of the nation’s richest 1% to the median household income — has skyrocketed since Ronald Reagan took office. In 1980 the average 1-percenter made 12.5 times the median income, but in 2006 (the latest year for which data is available) the average income of our richest 1% was a whopping 36 times greater than that of the median household.

Brandeis understood that at some point the concentration of economic power could undermine the democratic requisite of dispersed political power. This concern looms large in today’s America, where billionaires are allowed to spend unlimited amounts of money on their own campaigns or expressly advocating the election of others.

We believe that we have reached the Brandeis tipping point. It would be bad for our democracy if 1-percenters started making 40 or 50 times as much as the median American.

Enough is enough. Congress should reform our tax law to put the brakes on further inequality. Specifically, we propose an automatic extra tax on the income of the top 1 percent of earners — a tax that would limit the after-tax incomes of this club to 36 times the median household income.

Importantly, our Brandeis tax does not target excessive income per se; it only caps inequality. Billionaires could double their current income without the tax kicking in — as long as the median income also doubles. The sky is the limit for the rich as long as the “rising tide lifts all boats.” Indeed, the tax gives job creators an extra reason to make sure that corporate wealth does in fact trickle down.

Here’s how the tax would work. Once a year, the IRS would calculate the Brandeis ratio of the previous year. If the average 1-percenter made more than 36 times the income of the median American household, then the IRS would create a new tax bracket for the highest 1% of income and calculate a marginal income tax rate for that bracket sufficient to reduce the after-tax Brandeis ratio to 36.

This new tax, if triggered, would apply only to income in excess of the poorest 1-percenter — currently about $330,000 per year. Our Brandeis tax is conservative in that it doesn’t attempt to reverse the gains of the wealthy in the last 30 years. It is not a “claw back” tax. It merely assures that things don’t get worse.

A key aspect of our proposal is the tax’s automatic nature. Congress need only act once to protect our future. Just as our tax brackets automatically adjust with the inflation rate, Congress could specify nondiscretionary conditions under which the Brandeis tax would automatically go into effect. ...

The Occupy Wall Street movement is right to decry the increasing power of the 1 percent as a threat to democracy. President Obama is right to characterize the present as a “make-or-break moment” for the middle class. As 1-percenters ourselves, we call on Congress, for the sake of democracy, to end the continued erosion of economic equality in our nation.

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If implemented as described, this plan would result in a top bracket surtax alternating between very high and almost zero. Here's how. High income levels would trigger a high tax rate the following year. The high tax rate would reduce reported taxable income, resulting in a low measure of inequality. so the next year would have a very low surtax. The low surtax would trigger reporting of pent-up gains and other taxable income, restarting the 2-year cycle.

The authors don't appreciate the fact that rich people have many legal ways to increase or decrease their taxable income, first and foremost by choosing when to sell and when not to sell appreciated assets.

Posted by: AMTbuff | Dec 19, 2011 2:55:27 PM

I thought this was another satire, like the marriage tax article, but it apparently wasn't. (Oh, and by the way, data later than 2006 is available, it just does not conform to the authors' position.)

If I am reading their proposal correctly, income above $330,000 would be heavily taxed and income above a certain point would be subject to a 100% tax. I guess at some point the authors really do believe that you've earned enough income. At some point the authors believe that to retain democracy it is necessary to tell the rich, "off with your income." How wonderfully democratic. But I guess difficult times call for difficult solutions.

There is a part of me - the professional tax planner who grew up with the 70% tax on unearned income - that would welcome the financial bonanza that would result as the wealthy refused just to lie down and pay. Just think of the money to be made from baseball, the NBA and actors who make $20 million a picture.

There's always a silver lining in each brave new world.

Oh, and a personal joke for me is that I can claim a relationship to Brandeis. Although I was assured by an elderly law school professor who knew Brandeis, that he saw no evidence of the realtionship in my work. An actual true story and one of my greatest law school memories.

Posted by: Ed D | Dec 19, 2011 4:54:09 PM

But why should Congress bury this wealth redistribution scheme in the tax code? Instead let Congress legislate open and visible subsidies for persons less well off, at the increased risk of getting voted out of office.

Posted by: Jake | Dec 19, 2011 6:53:41 PM

If the data is only available as recently as 2006, and the tax would be adjusted to control the ratio in each year, would we have to wait 5 years to know what the tax rate for 5 years ago should be?

Posted by: Jeremy LaMrouex | Dec 20, 2011 5:18:54 AM

Actually, if you wish to check the IRS Statistics of Income (SOI), it is currently available through 2009. The "inequality" ration dropped precipitously in 2007/2008 as the market crumbled since the uberwealthy are more heavily invested than the lower quintiles.

Jeremy L's practical point reminds me of Orwell's statement that some ideas are so stupid only intellectuals would believe them

Posted by: Ed D | Dec 20, 2011 8:22:45 AM

Jeremy, not if you actually read the exert or op-ed.

Posted by: the real anon | Dec 20, 2011 10:30:15 AM