April 25, 2012
Diamond & Saez: High Tax Rates Won't Slow Growth
The share of pre-tax income accruing to the top 1% of earners in the U.S. has more than doubled to about 20% in 2010 from less than 10% in the 1970s. At the same time, the average federal income tax rate on top earners has declined significantly. Given the large current and projected deficits, should the top 1% be taxed more? Because U.S. income concentration is now so high, the potential tax revenue at stake is large.
But will taxable incomes of the top 1% respond to a tax increase by declining so much that revenue rises very little or even drops? In other words, are we already near or beyond the peak of the famous Laffer Curve, the revenue-maximizing tax rate?
The Laffer Curve is used to illustrate the concept of taxable income "elasticity,"—i.e., that taxable income will change in response to a change in the rate of taxation. Top earners can, of course, move taxable income between years to subject them to lower tax rates, for example, by changing the timing of charitable donations and realized capital gains. And some can convert earned income into capital gains, and avoid higher taxes in other ways. But existing studies do not show much change in actual work being done.
According to our analysis of current tax rates and their elasticity, the revenue-maximizing top federal marginal income tax rate would be in or near the range of 50%-70% (taking into account that individuals face additional taxes from Medicare and state and local taxes). Thus we conclude that raising the top tax rate is very likely to result in revenue increases at least until we reach the 50% rate that held during the first Reagan administration, and possibly until the 70% rate of the 1970s. To reduce tax avoidance opportunities, tax rates on capital gains and dividends should increase along with the basic rate. Closing loopholes and stepping up enforcement would further limit tax avoidance and evasion.
But will raising top tax rates significantly lower economic growth? In the postwar U.S., higher top tax rates tend to go with higher economic growth—not lower. In the postwar U.S., higher top tax rates tend to go with higher economic growth—not lower. Indeed, according to the U.S. Department of Commerce's Bureau of Economic Analysis, GDP annual growth per capita (to adjust for population growth) averaged 1.68% between 1980 and 2010 when top tax rates were relatively low, while growth averaged 2.23% between 1950 and 1980 when top tax rates were at or above 70%.
Neither does international evidence support a case for lower growth from higher top taxes. There is no clear correlation between economic growth since the 1970s and top tax-rate cuts across Organization for Economic Cooperation and Development countries.
TrackBack URL for this entry:
Listed below are links to weblogs that reference Diamond & Saez: High Tax Rates Won't Slow Growth :
The old treadmill theory of economics, ay? Hey, after all, our purpose in life is to feed government. Here is an alternative. If a swimming pool for the community is such a good idea...why hasn't some entrepreneur built one. Quick answer, cost doesn't pencil out. Most of what government does doesn't pencil out. Pass a law that requires government projects/programs must be positive cost vs benefit, measured under private industry guidelines. Or better yet, pass a law, to whit: It shall be illegal to spend money on bad things.
Posted by: gregger | Apr 26, 2012 2:25:05 PM