Chairman Ryan has called for cutting the top marginal tax rate to 25 percent, and he has also called for eliminating tax expenditures — though he hasn’t specified which. Does this mean that he is cutting taxes on the rich? Well, without knowing more about which tax expenditures Ryan intends to eliminate, all we can safely say is that his approach will cut taxes on some rich people. It will almost certainly cut taxes on people at the far right edge of the taxable income distribution in any given year, a space where there is considerable volatility from year to year.
But it also seems likely that the Ryan approach will raise taxes on many other rich people, and many HENRYs, i.e., earners in the neighborhood of $250,000 to $500,000.
So how should we think about this? Well, some of our friends see this as a political slam dunk. Ryan wants to cut taxes for the richest people! Or, more accurately, Ryan wants to cut taxes on the people who earn the most in a given year!
Think about the woman who spends X number of years building a company, and she happens to realize a lot of money in a particular year. The top rate of tax might have an impact on when you decide to realize your gains. People respond differently to a permanent tax rate than they do to a temporary tax rate, for obvious reasons.
And that’s the thing: it might actually be a safer bet revenue-wise to try to raise revenue by taxing the permanent incomes of HENRYs and richer households that don’t quite reach the tippy-top by paring back their tax expenditures. In this scenario, many of these taxpayers, particularly homeowners living in high-tax jurisdictions, would pay somewhat more than they are paying now. Renters living in low-tax jurisdictions might wind up paying somewhat less. We’d be leveling the playing field between owning and renting, and across jurisdictions. Here is what Joel Slemrod has to say on the subject:
Consider the itemized deduction for state and local income and property taxes, extended in the 2004 tax bill to state income or sales tax for the years 2004 and 2005. It is a subsidy for subfederal government expenditures at a rate that increases with the affluence of the jurisdictions’ residents, because more affluent taxpayers are both more likely to itemize their deductions in the first place and, if they do, are more likely to be subject to higher marginal tax rates, which is the effective rate of subsidy. It would never (and should not) be approved by Congress as a stand-alone subsidy program.
The same applies to the tax treatment of employer-provided health insurance, which is nuts.
“Wait a second. So is Reihan saying that we should tax the near-rich and the people at the tippy-top at the same rate, even if that represents an effective tax cut for, say, the highest-earning several thousand households in any given year?”
Yes, that is exactly what I’m saying. Why? Because I think the revenue we’d gain from something steeply graduated taxes would be outweighed by the loss in productive economic activity, per the work of Edward Prescott and the more recent work of Chetty et al.
One of the lines of attack we’ve heard and that we’ll be hearing much more of over the next year and a half is that conservatives who want to rebuild the Medicare program so that it offers a limited defined contribution towards the purchase of health insurance are motivated by a desire to cut taxes on the rich or, more plausibly, that this is the upshot of the Ryan approach that has been embraced by much of the right.
I’d put this differently, which will come as a shock, I realize. The goal is to put mandatory spending on a stable, sustainable path, which would enable us to keep tax rates for all households on a low, stable, and sustainable path as well. Base-broadening is an important way to get there, but base-broadening will create many losers among the politically influential upper-middle-class voters in the most affluent metropolitan areas. (I don’t think it’s a coincidence that those who object most strongly to this approach tend to belong to this group. It is shrewder to express one’s political objection by attacking the even richer, however.)
One of the big problems with the post-Reagan right has been an eagerness to cut taxes without addressing the drivers of spending growth. This has meant tax rates that are low but also unstable and unsustainable, as evidenced by the number of tax tweaks since the 1986 tax reform and rising deficits — which, of course, had other causes, among them the bipartisan effort to expand prescription drug coverage, when Congress ultimately embraced the somewhat cheaper Republican approach over the somewhat more expensive Democratic approach, and the wars in Iraq and Afghanistan.