The Agenda

Quick Backgrounder on High Marginal Tax Rates

I’ve noticed that some new readers seem to believe that hiking marginal tax rates on high earners is a no-brainer. It occurs to me that many readers aren’t regular readers, but rather people who’ve found their way here via the occasional link. So here are a few things to keep in mind:

(1) Raising marginal tax rates vs. broadening the tax base

The tax code offers many provisions — credits, deductions, exemptions, etc. — that have the effect of reducing taxable income. All of these provisions are designed to advance public policy goals, some of them more questionable than others. Actually, some of them were essentially accidents of history that acquired powerful constituencies over time, but the upshot is the same. Scholars call these provisions tax expenditures, because they operate much like any other spending program. Some critics say that this is unfair: these tax provisions allow taxpayers to keep money that is already theirs. And there’s something to that. But the tax code only allows you to keep the income you’ve earned if you’ve jumped through a certain hoop.

Some of these provisions, like the child tax credit and the EITC, mainly benefit households with low to moderate incomes. If the goal is to aid poor households, it often makes sense to make a tax credit refundable, i.e., to actually transfer cash above and beyond actual tax liability. But most of these provisions benefit the affluent. At higher tax rates, something like the tax exclusion for employer-sponsored coverage becomes more valuable, which creates a perverse situation in which we’re delivering a bigger benefit to the rich than to the poor. 

While there’s a decent case for retaining something like the EITC and the child tax credit, clearing out these other tax provisions would dramatically broaden the tax base and simplify the onerous process of figuring out what taxpayers owe the federal government. And clearing the code of tax expenditures would also raise far more revenue than creating new tax brackets for high earners.

(2) Bang-for-the-buck

People often say, “I know a great way to raise tax revenue. We’ll create a X percent bracket for people making (whatever I earn in a given year)(n).” There’s a problem, however: you’re only gaining revenue from the incremental increase, but the disincentive effect is as strong as if you were taxing all income at the new rate. 

(3) How big are these disincentive effects anyway? 

Here we have a big, ongoing debate: everyone agrees that taxes have some disincentive effect, but how strong is this effect and when does it kick in? My colleague Arpit Gupta has written on this subject for Economics 21 a number of times, and I’ve shamelessly promoted his posts. His commentary on “Tax Increases and Behavioral Responses” does an excellent job of summarizing the state of the debate.

I am in the camp that believes that we need more tax revenues but also that we need much lower marginal tax rates and lower taxes on capital income. 


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