The Agenda

How Close Are We to the Top of the Laffer Curve Again?

Recently, Arpit Gupta wrote an excellent analysis of recent arguments advanced by Emmanuel Saez and Peter Diamond regarding the top marginal tax rate: 

While many commentators have seized upon this paper as representing new evidence; all Saez and Diamond here do is calculate the top of the Laffer Curve given estimates from prior papers (including one of their own — more on that later). They conclude that, taking the tax code as given, the top marginal income tax rate should be 48%; but it could be as high as 76% if the tax code was shorn of deductions.

It is worth noting that virtually all tax reform proposals propose maintaining at least some deductions. Even the Zero Plan advanced by the Bowles-Simpson fiscal commission was primarily meant for illustrative purposes. This means that taxpayers will continue to have an opportunity to reduce their taxable income by increasing deductible consumption, a phenomenon my Economics 21 colleagues have discussed in detail.

This leads us to an interesting question. Where is the top rate of marginal tax likely to go if we roll back the high-income rate reductions of 2001 and 2003? Alan Viard attempted to answer that question in the fall of 2010, before the temporary extension of the Bush-era rates passed later that year. Factoring in an increase in the Medicare tax and the new Unearned Income Medicare Contribution, Viard found that

virtually all of top earners’ ordinary income will be taxed at 44.6 percent, starting in 2013. We’re not just going back to the Clinton-era rates of 40.8 and 43.7 percent.

Capital gains taxes will likely increase to 25 percent while taxes on dividends could range from 25 percent to 44.6 percent. Suffice it to say, this will tend to exacerbate the debt bias in the tax code unless some affirmative step is taken to cap the deductibility of corporate debt. 

So it looks as though Saez and Diamond will soon get their wish and that the top marginal tax rate will soon approach 48%. Indeed, it will comfortably exceed that level in a number of jurisdictions once we factor in state and local levies, including New York city.

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