In a post last week — “Taxes at the Top” — I suggested that higher tax rates on the richest Americans very likely would increase government revenues. Austan Goolsbee has a closely related discussion in Sunday’s New York Times (here; comment by Mark Thoma here).
Goolsbee addresses the “supply-side” argument that lower tax rates on top earners will produce a rise in their earnings and pretax incomes, due to greater investment or work effort. That might increase tax revenues. Goolsbee argues, and shows, that the evidence doesn’t support this claim. He focuses on the effect, or lack thereof, of changes in the top marginal tax rate:
“My calculations show that in the four years after top marginal rates were cut in 1981 and 1986, and in the three years after the rate cut of 2003, average real salaries (subtracting inflation) for the top 1 percent of earners grew 18.8 percent, 22.5 percent, and 17.4 percent…. A supply-sider might see this as evidence of the growth power of cutting top rates. But the data also show that incomes at the top have been growing rapidly regardless of what happened to tax rates. In the four years after the increase in top marginal rates in 1993, average salaries grew 18.7 percent among the top 1 percent of earners…. Seeing the same pattern when taxes rose as when they fell indicates that tax cuts weren’t responsible.”
The effective tax rate on the top households is more meaningful than the marginal rate. The chart below shows trends in the effective rate and in the pretax income of the top 1% of households. The data are from the Congressional Budget Office (here).
Goolsbee’s conclusion holds. The effective tax rate on the top 1% was reduced from 37% to 28% between 1979 and 1982. In the ensuing five years the average pretax income of the top 1% jumped sharply. But between 1990 and 1994 the effective rate on the richest was raised from 29% to 36%, and in subsequent years pretax incomes at the top rose even more dramatically.