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At Tax Time, Our Emperors Have No Clothes

Research & Commentary
April 06, 2013


Today’s conventional wisdom in Congress on taxing the rich — that tax rates on income at our economic summit have gone as high as they can sensibly go — has no real evidence to support it.

By Sam Pizzigati

Credit: Forbes

Source: Forbes

This past January, Congress raised the federal tax rate on joint return income over $450,000 from 35 to 39.6 percent. But the top federal rate, even with this boost, is still running under half the top rate back in America’s Eisenhower years.

What to do? Some Democrats in Congress — the members of the Progressive Caucus — want to raise the nation’s top tax rate still higher, up to 49 percent on annual income over $1 billion.

But no big-time movers and shakers in Washington, from either party, support higher top rates. Republicans typically claim that higher rates would undermine the incentive to work, save, and invest. GOP hard-liners even balk at moves to shut tax loopholes. Any step that hikes tax bills, they hold, invites calamity.

Mainstream Democrats, for their part, generally consider higher tax rates and moves to close tax loopholes an either/or proposition. Instead of raising current top rates, they argue, we should keep top rates modest and apply these modest rates to the “broader tax base” that limiting loopholes would create.

Not all these lawmakers, of course, agree on what constitutes a loophole. More Wall Street-friendly Democrats, for instance, gag at the thought of ending the enormously lucrative tax break for capital gains, the profits from buying and selling stocks and other assets that flow overwhelmingly to America’s richest.

The bottom line? For an assortment of reasons, congressional majorities on both sides of the aisle have come to what amounts to a “bipartisan consensus” on increasing tax rates at the top. That consensus: don’t do it. [pullquote]The congressional bipartisan consensus on top tax rates: don’t raise them.[/pullquote]

Few lawmakers dare to challenge this admonition. But this timidity makes no sense. The current consensus against higher top tax rates, as analyst Andrew Fieldhouse details in a just-released study for the Economic Policy Institute and the Century Foundation, rests on an amazingly shaky foundation.

Fieldhouse’s new paper, A review of the economic research on the effects of raising ordinary income tax rates, walks us through the last decade of top-notch research on top tax rates and, along the way, readily demolishes conservative claims that high taxes on high incomes will doom America to economic despair.

Tax rate reductions since the 1970s, the research shows, haven’t strengthened the economy. They’ve had “a statistically insignificant impact” on the factors that drive economic growth: labor supply, savings, investment, and gains in productivity.

What these rate cuts have done: They’ve “discernibly widened,” Fieldhouse relates, “structural budget deficits and exacerbated income inequality.”

Fieldhouse also shows — and this may be his paper’s most politically significant contribution — that efforts to broaden the tax base and efforts to raise top tax rates can and should go hand in hand. His explanation why revolves around the concept of taxable income “elasticity,” economist-speak for how the income taxpayers report may rise and fall with changes in tax rates.

This elasticity — how taxpayers behave at tax-reporting time — depends in large part on the loopholes the tax code offers.[pullquote]Moves to raise top rates and close loopholes can and should go hand in hand.[/pullquote]

If loopholes beckon at every turn — and efforts to enforce the tax code’s integrity remain lax — wealthy taxpayers just step up their tax-avoidance efforts when taxes rise. The IRS ends up collecting less revenue than the agency would have collected had the wealthy not stepped up their avoidance behaviors.

By contrast, if Congress seriously went after loopholes — and toughened up tax law enforcement — wealthy taxpayers would have fewer avoidance options. “Elasticities” would fall. The new tax revenue collected from higher tax rates would increase.

In sum, writes Fieldhouse, “base-broadening tax reform and higher marginal rates should be seen as complements, not substitutes.”

The payoff if we do both? Oh, not much: just more tax revenue to fund programs that help average American families, a stronger overall economy, and a meaningful pushback against growing inequality!

Recent economic research, Andrew Fieldhouse goes on to add, puts the optimal top tax rate for maximizing revenue at just north of 66 percent, well above the current top rate.

Top tax rates in the United States used to flutter in that lofty vicinity. Moving back closer to those top rates, Fieldhouse’s new study helps us understand, would make wonderful sense economically.

Sign up for To MuchWhether that move back to higher tax rates at the top comes to make sense politically to America’s lawmakers depends, of course, on the rest of us — and the political pressure we choose to bring to bear.

Labor journalist Sam Pizzigati, an Institute for Policy Studies associate fellow, writes widely about inequality. His latest book, The Rich Don’t Always Win: The Forgotten Triumph over Plutocracy that Created the American Middle Class, 1900-1970, has just been published.

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