For many progressives it is an article of faith that tax rates on the richest Americans should be higher than they currently are.
Why? One reason is that it would be fairer. In the 1950s the top marginal income tax rate was 90%, and it was 70% as recently as 1980. These days the top rate is only 35%.
That’s misleading, however, because prior to the mid-1980s the tax system had a lot more loopholes and deductions than it does now. The meaningful tax rate is the “effective” rate — the share of their income that people actually pay in taxes. The following chart shows the top marginal rate and the average effective rate on the top 1% of taxpayers since World War II. The latter is from calculations by the Congressional Budget Office (here) and is only available beginning in 1979. (As of 2005, a four-person household in the top 1% had a pretax income of $600,000 or more.) The effective rate is lower now than it was in the late 1970s and in the mid-1990s.
Some opponents of higher tax rates for the rich argue that fairness in taxation requires that everyone’s income be taxed at the same rate. Taxation should be proportional rather than progressive. Not many people seem to share this view, however. Most feel that because they can afford to, the richest should pay not only more dollars but also a larger share of their income.
A second rationale for higher taxes on the most well-to-do is that it would increase government revenues, which could be used to help improve opportunity and outcomes for those less fortunate. Health care for all, a more generous Earned Income Tax Credit, and subsidized preschool and child care are among the many good ideas currently on the table.
The taxes paid by those at the top matter a great deal for government finances. As of 2005 the top 1% accounted for 28% of federal government tax revenues. That isn’t because they are taxed at an outlandish rate; an effective tax rate of 30-40% is hardly confiscatory. Instead, it’s because they get a very large share of the country’s income — 18% as of 2005.
The following chart shows federal government tax revenues as a share of GDP by the effective tax rate on the top 1%. The data points represent each year for which data are available. Although the correlation is far from perfect, tax rates on the richest are positively associated with the portion of GDP collected in taxes. This is as we would expect. It suggests that steeper tax rates at the top are likely to bring in more revenue.
But not so fast. It is commonly objected that higher tax rates on the affluent will reduce incentives for saving, investment, entrepreneurialism, and hard work. Economic growth will slow. Thus, taxes will be collecting a larger share of a less-rapidly-growing economy. In the end, higher tax rates will yield no increase (and perhaps a reduction) in government revenues.
Is this true? A lot of research has been done on this question, but there is little agreement about the answer. (For a helpful overview, see Joel Slemrod and Jon Bakija, Taxing Ourselves.)
The next chart shows the growth rate of per capita GDP by the effective tax rate on the top 1%. The effective tax rate on the richest appears to have had no noteworthy impact on economic growth. Averaging growth over several years does not change the picture.
What about the effect of tax changes? As the first chart above indicates, the effective tax rate on the top 1% fell sharply between 1979 and 1982. In the five-year period beginning in 1982 the growth rate of per capita GDP averaged 2.6%. By contrast, the effective rate on top incomes jumped appreciably between 1990 and 1995. Yet over the five-year period starting in 1995 the average rate of economic growth was virtually identical: 2.7%.
There have been several smaller changes in the high-end effective tax rate since the late 1970s. In the late 1980s the rate increased slightly, and in the late 1990s it declined slightly. In both of these instances, however, assessment is complicated by the fact that recessions occurred fairly shortly afterwards. More recently, between 2000 and 2005 the top rate was reduced from 33% to 31%. Per capita economic growth in the mid-2000s has been relatively weak for a non-recession period, at just a little more than 2% per year, but it is too early to fairly judge the impact.
To sum up: The effective tax rate on the incomes of the top 1% of Americans is substantially lower now (31%) than it was in the late 1970s (37%) and in the mid-1990s (36%). When the rate is higher, the federal government tends to collect a larger share of the national economy in taxes. And the experience of the past several decades suggests that higher rates have had no adverse impact on growth of the economy.
This evidence is by no means conclusive. But it lends credence to progressive hopes that a somewhat higher rate of taxation on the richest Americans would not only be fairer but also enhance the government’s ability to provide valuable services and benefits.