Adam Ozimek at Modeled Behavior has a really great post on this question. It is a reply to Paul Krugman’s argument that, basically, high-income people get back in compensation their total value creation for the entire economy. For example, if Steve Jobs made a gazillion dollars, that means he created a gazillion dollars of value, but took it all back as his compensation; therefore, had Steve Jobs never existed, nobody else in the world would have been any worse off. This is a simplification, but one of the great things about the post is that Ozimek carefully pins down the reasonable interpretation of Krugman’s actual assertion by going back to Krugman’s textbook writing.
Krugman argues that if we accept the premise that people get their marginal product of labor back as compensation, then why not set marginal tax rates to the level that maximizes government revenue: 70 percent?
Ozimek’s simple, great thought-experiment in the post:
Consider, for instance, that if we suddenly kicked out the top 10% of high IQ people (or 10% most productive people, or 10% most creative people, or whatever) in the U.S.. It strikes me as fairly likely that the total output of the remaining 90% would go down. Krugman seems to argue that this would not be the case. But even if you disagree with me in the short run, in the long-run the productivity increasing innovations these people would have made won’t show up, and the rest of us would have lower productivity as a result.
Now, instead of kicking out the top 10% of workers, just make them work less as a result of high income taxes. See my concern?
Lowered incentives of job creators and other innovators should be considered as one of the likely downsides to higher taxes.
Note that if you don’t think this is true, then what business do we have subsidizing higher education? If workers capture the entirety of their higher productivity, then I don’t see who gains by giving young people money to go to college rather than just cash.
I’d only add one observation.
Krugman ends his piece with this:
My point, then, is that this claim — and the lionization of high earners as people who make a vast contribution to society — is not, in fact, something that comes out of the free-market economic principles these people claim to believe in. Even if you believe that the top 1% or better yet the top 0.1% are actually earning the money they make, what they contribute is what they get, and they deserve no special solicitude. [boldface added]
What’s so funny about this is that Krugman is arguing that “these people” (i.e., people like me who think that a 70 percent marginal tax rate is not necessarily a good idea for America as whole) base our beliefs about political economy on his textbooks. He is pointing out a contradiction that exists only in his mind. I don’t accept his pseudo-scientific claims to knowledge about the impacts of doubling our maximum tax rate; my “free-market economic principles” are in fact based in part on my beliefs about the inherent uncertainty of such predictions.