The optimal rate of income taxation

An established view is that the revenue maximizing top tax rate for the US is approximately 73 percent. The revenue maximizing top tax rate is approximately 49 percent in a quantitative human capital model. The key reason for the lower top tax rate is the presence of two new forces not captured by the model underlying the established view. These new forces are strengthened by the endogenous response of top earners’ human capital to a change in the top tax rate.

That is from a recent paper by Badel, Huggett, and Luo, via Scott Winship.

Comments

Why on Earth would revenue maximizing be the goal of tax policy? Seems like putting the cart before the horse, no?

Is over tax rates and their consequences.

For a long time I felt as if Tyler just wanted to be liked by Paul Krugman. Almost as if Paul was his big broher and Tyler just wanted Paul to accept/like him.

But now it is rather obvious that Tyler is the more astute public intellectual. Did you see their coversation recently? Tyler was relaxed and confident, and had a convincing answer for everything they discussed. Paul was nervous and frankly seemed out of his league. I read everything Tyler writes because it is always so thoughtful and insightful while Paul is still snide, partisan and redundant in his writing.

This is going to be a very interesting conversation that unfolds in the next couple of years and I am fairly certain Tyler arguments will be considered the correct ones.

The revenue-maximizing rate is important, because it sets an upper limit to the tax rate debate. Nobody is going to openly advocate for raising the rates so high that marginal increases aren't even bringing in additional revenue (perhaps a few extremists want punitive taxes on the rich, regardless of benefit, but this view would get no political traction).

The current proposals from the left of raising the rate to around 70% are dependent on conventional wisdom that raising the rates to this would raise a lot of additional money for the government to spend on stuff. If the revenue maximizing point is really 49%, that is likely not true, because we are already close to it (top rate of about 40%, plus state taxes in many cases).

p.s. after skimming the paper, I'm not sure if their optimal top rate for the U.S. is for just federal taxes, or federal + state.

If it's federal + state, taxpayers in the highest-tax states are very close to 49% already.

Higher. I'm in California.

Top Fed rate is 35%, top CA rate is 13.3% only over $1 mil in income. So, not higher. And since you make less than $1 million it's even less.

The top Federal marginal tax rate for fiscal 2018 is 37%.

But by eliminating tax dodges, capital is being destroyed in NYC and California, as the rich sell their multimillion dollar homes for a few hundred thousand and move to low property tax and low housing cost Texas.

This is however, a great result as the working poor will be able to buy cheap 50,000 sq ft homes for $250,000 and rent rooms to their homeless coworkers.

And we know the homes bought for tens of millions before Trump are selling for only a few hundred thosand because markets are zero sum. No person will pay tens of millions for homes because they will not be able to dodge taxes, but those who bought homes at tens of millions for the big tax dodges before Trump, are now desperately selling at any price to move to Texas.

Tens of billions in housing wealth vaporized.

And now lots of low cost housing in NYC and California!

;-)

Not only does "maximum revenue raising" not the same as "optimal", but I have it on good authority that the optimal tax rate is the one which leads to the highest long term growth (i.e. causes the least economic harm in the private sector). That rate also turns out to be revenue maximizing, not for this year, but for some future year, because of the bigger tax base compounding over time.

Obama proposed exactly that in 2011 - that tax rates be set at a higher “fairness” rate rather than on revenue optimization.

I hadn't remembered that.

Oh, how times change.

"Trump told supporters 40-50% of speech will be about foreign policy. When asked if the deficit will be mentioned in #SOTU speech, chief of staff Mulvaney said “nobody cares,” per attendee"

How's that a response to Engineer?

I think that the view that taxes are fundamentally punishment for the crime against humanity of accumulating wealth is the mainstream view of the Democratic party today.

Finally some common sense around here! But really if the Dems could they would murder all the rich people (except Soros, and maybe Buffett) and skip the taxes.

#MAGA2020

^although the maximal revenue-raising tax rate is a relevant background concept, the only reason it is being brought up in the current political discussion is to mislead.

you constantly see subtle equivocations between "maximal" and "optimal," which are used to imply some sort of economic consensus that 70% is an appropriate policy target.

the politicians never openly say "my proposed rate is a good idea because it will extract as much money from taxpayers as is humanly possible." because voters realize that is madness. left-leaning economists/bloggers have raised a fake "debate" over the maximal-rate issue to provide cover for democrat candidates who really do have that goal in mind.

This paper certainly isn't providing cover for leftists, as the 49% finding would not leave a lot of room to raise taxes.

Indeed,

US + California top marginal tax rate: 37+13.3 = 50.3%

One might say that the revenue maximizing top rate would allow Government to lower the taxes in the other brackets.

The U.S. already has the most progressive federal income tax in the world

A progressive tax system, by definition, is one where average rates rise with income. A more progressive tax system is one where average rates rise more sharply with income. The most progressive tax system is the one where rates rise most sharply with income.

This does not, to my knowledge, describe the US tax system, where rates rise only slowly with income.

I suspect you're talking about percentage of tax paid by the highest x% of the populace, for various arbitrary values of x. This correlates with a system's progressiveness, but not particularly well, because it also depends on income distribution.

@Paul - if you google "most progressive income tax in the world" your new knowledge might suddenly have you much closer to the position of @Anonymous.

"Why on Earth would revenue maximizing be the goal of tax policy?"

Maximum revenue occurs when taxes on wages are the only source of tax revenue and wages entirely paying for consumption of good, durable or not.

Ie, businesses have no economic profit, and individuals are paid wages that pay for a high cost of living with no wages or incomes used to seek monopoly power over assets to cut production/consumption to generate rent seeking and monopoly profits.

This is a lesson I learned reading Milton Friedman Newsweek columns, after reflecting on the implications of his view that high tax rates and tax dodges produced too much growth in labor costs, too much investment in capital, and too much consumption by househollds in wasteful cars, houses, appliances which only fed an endless cycle of hiring too many workers producing too much wasteful stuff and too much capital, increasing living costs too much.

He argued at different points, the US was producing too much oil because Federal taxes promoted wasteful drill baby drill policies.

On that point, he won bipartisan agreement, and almost like a switch, drilling in the US was slashed, and US oil production began a relentless decline for the next three decades. Only Congress dictating drill baby drill in Alaska, after rejecting drill baby drill in North Dakota.

Friedman argued that lower oil prices by importing oil from Saudi Arabia would be best by eliminating harmful, destructive to profits paying of US oil workers.

However, he did not declare the massive destruction of wasteful jobs in Texas and Oklahoma during the 80s and 90s as victories for his policy advice because he was a very modest man. Others, however touted the resulting forced reduction in reduced consumption as a virtue, the lower cost of living.

But if low cost of living is a virtue, then Africa beats Texas by miles.

Europe has adopted Friedmans tax advice, lower tax rates, and eliminating tax dodges. In Europe, the primary taxes are flat rate taxes on business revenue with zero deductions for paying workers, only deductions for costs on which taxes have already been paid. The VAT. And fllat rate taxes on wages, just like FICA, but without the tax dodge of a cap on taxes, and more such taxes. And more flat taxes on consumption, eg fuel taxes.

Of course, Friiedman would argue Europe has over invested in capital, providing too much easy transportation, too much human liberal education, too much healthy life. Better that Europeans had to suffer in life, with hard travel, no ability to appreciate wasteful art, music, food, and work themselves to death.

Eg, a good puritan lifestyle. Or orthodox of all faiths in the Mideast.

Still, there's quite a lot of room between 37% and 49%.
Which is what might matter most in terms of the politics.

As a matter of arithmetic, there is a 12 percentage point difference which, arguably, is "a lot of room". However, when calculating the "optimal marginal tax rate" one takes into account *all* taxes and not just the federal income tax. That's not just me talking. That's Emmanuel Saez, et al as well.

Any idea what the marginal tax rate is today if one includes all taxes in the United States? Hint: It varies depending on the type of income concerned. It would be a good idea to agree on the actual current rate before starting a discussion about what the "optimal rate" might be.

Further, since the "optimal marginal tax rate" is typically defined against *income* as a measure, what effect would adding a wealth tax on top of all existing taxes (even at current rates) have to that calculation?

The paper, I think, is considering only income taxes (after accounting for the impact of other taxes) when reporting the 49% rate. I'm not sure whether state taxes are included or not.

The more you consider all taxes, including the better hidden ones, the more you are talking about econs, rather than people.

I applaud these papers, even if I don't understand them, but I do appreciate that they provide theoretical limits.

In practice anything should be a stepwise change, watching for consequences expected and unexpected.

Whether you're going up or down, stair step plans are better than great leaps.

"The more you consider all taxes, including the better hidden ones, the more you are talking about econs, rather than people."

So, you want to include only the federal income tax as the only tax paid by "people"? I don't think the bottom ca. 50 percent of the US income distribution appreciate you implying that they are "econs".

That's not what I said, obviously.

A more neutral reading would be that different parts of the total (direct and indirect) taxes paid by an individual have different salience.

https://thedecisionlab.com/bias/salience-bias/

Does "econs" rhyme with peons?

Not at all, it was a Thaler reference with quite a different meaning.

https://www.bls.gov/opub/mlr/2016/book-review/behavioral-economics.htm

No, obviously it doesn't have the same leading consonant before the last accented syllable.

I have a wonderful proof it is not so, but this napkin is too small to contain it.

Well, what a coincidence. The proposal to impose social security taxes on income above $400,000 would result in a top marginal rate of about 49%. Let's do it.

Said someone ignorant of state and local tax rates

Optimal for whom? The evil crazies that comprise the ruling class?

Confiscating wealth never increased any nation's prosperity.

It's not new. They weaponized taxes for political purposes.

Dulce Tributum Inexpertis.

Maybe you should name that successful country that never confiscated anyone's taxes?

Republican Rome and pre-Civil War USA, when it was still a republic.

There is a problem with your examples. Both of them are nations that accepted slavery.

I lean more libertarian than 95% of people here. I think the American constitution is near perfection, I wish we could live under it.

But I find it very problematic, that for nearly 90 years, the early independent Americans (as opposed to colonist Americans prior) could harbor the cognitive dissonance that the constitution is consistent with a group of people being born into slavery. The second cognitive dissonance, independent of the constitution, is how they could not see the equivalence between stealing (8th commandment) and taking the kid of your slave as your slave.

As a disclaimer, I wholeheartedly agree with the strict textual interpretation, "Neither slavery nor involuntary servitude, except as a punishment for crime whereof the party shall have been duly convicted, shall exist within the United States, or any place subject to their jurisdiction. ", by which one could in theory be sentenced to slavery, and sold off in order to pay partial restitution.

No cognitive dissonance if you don't think black people are actually human beings. Slavers didn't.

The Constitution was and is a positive law (full stop), and, prior to December 1865, it's provisions in black letters were consistent with a regime of hereditary subjection. There's no mystery there.

I stand corrected, the declaration of independence is not codified law, so life, liberty and pursuit of happiness are not constitutionally guaranteed?

https://en.wikipedia.org/wiki/United_States_Declaration_of_Independence#Slavery_and_the_Declaration

Rome didn't levy taxes? What was that tax collector doing in Luke 18: 9-14?

The Roman Republic conscripted nobility, who probably conscripted their subjects,which is a form of taxation. In the case if successful military campaigns with conquests, this taxation could be more like an investment vehicle, to the victors go the loot!

However, quoting the new testament means the Roman republic already was over, as Augustus obviously was an emperor, and the sanate's power was diminished.

A 30% optimal tariff on imports would raise a tidy half a trillion a year...

And who will pay that half trillion?

A 30% tariff wouldn't raise half a trillion a year if consumers responded by buying few imported goods.

And our trading partners would surely retaliate, leading to substantially lower exports and thus less tax revenue from the export sector.

Lastly, now that you've jacked up the price of intermediate goods and raw materials, finished products in the US would become far more expensive both reducing domestic consumption and reducing exports even further.

You might get half a trillion in new tariff revenue in the first year but by year three or four you'd be in a deep depression and tax collection across the board would collapse.

Optimal != revenue maximizing, surely.

Optimal for who? A rights-violating dictator? Next economic question: Optimal number of old people to be covered into Soylent Green for maximum utilitarian happiness?

I still think this was the best thing written on that.

https://niskanencenter.org/blog/cant-make-government-smaller/

I don’t see how one can talk of an optimal tax rate without discussing the tax base. Are they assuming a perfect Haig-Simons tax base?

Why is that rate just the "top" tax rate? Why not a 73% flat tax on everyone? Is the goal redistribution, or is the goal maximizing government revenues?

And for all the talk about immigration, do any of these models capture immigration? Would immigration of top talent be affected by the top rate? It is curious that Saez may like high top rates, but he left his native high-tax France for the U.S.

So the owner of the Patriots would relocate to India and buy a cricket team if tax rates became higher in the US?

No - but he might spend $200mil on a new supersonic jet he wouldn’t otherwise buy.

The twin pillars of leftism:

(1) The USA is ruled by a fascist, sexist, racist tyrant.

(2) Now, how can we get him more money and power over our lives?

Obviously the real power remains in congress. We kept spending contrary to the net taxpayers' interest even when the government was shut down, even though in theory, the tiny amount of discretionary spending was eliminated.

Of course, the president has angered the powers that be, by decreasing foreign war actions.

Arguments about the top tax rate are irrelevant until steps are taken to prevent folks from hiding income and wealth and until special interest loopholes are closed. That is the real argument.

Eliminating existing deductions would be a good first step. Simplify the tax code. Get rid of special classifications when possible. Etc.

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