Debunking the idea of lower tax rates for rich

Vijay K. Mathur

Published in Standard-Examiner, Ogden, Utah, June 15, 2012

Right-wing conservative media pundits, journalists, and their sympathizers in the Congress and think tanks, bombard us with constant one-liners that federal income tax rates are too high, and the cure for our unemployment problem is lowering federal income tax rates. Obama administration has proposed increasing tax rates on the rich and lowering the rates on middle- and low-income Americans to raise revenue. But the followers of Grover Norquist's "no tax increase pledge" in the Congress have constantly opposed raising tax rates on the rich.

This opposition to raising tax rates on the rich follows the same old reasoning that increasing taxes on the rich will reduce growth, increase unemployment and hence decrease tax revenues. Therefore, one questions if this stand on taxes is based upon sound economic analysis or is it just old political and bipartisan rhetoric meant to misinform Americans about the effect of increasing taxes on the rich? A recent major study published in the Journal of Economic Literature, March 2012, by Emmanuel Saez, Joel Slemrod and Seth H. Giertz (SSG), provides very convincing evidence that increasing marginal income tax rate (rate when income exceeds an individual's tax bracket by an extra dollar) more than the current 35 percent rate for the top 1 percent of income earners will increase federal government revenues.

SSG find that under very reasonable assumptions, supported by vast literature on tax issues, when one combines maximum federal and average state income tax rates, Medicare and average sales tax rates in the U.S., the top marginal tax rate on ordinary income as of 2009 is 42.5 percent, the estimated revenue maximizing tax rate is 72.2 percent and the estimated corresponding top federal income tax rate is 68.4 percent. These estimates are substantially higher than the current top marginal tax rate of 35 percent. It should be emphasized that no one in the Obama administration is proposing such high rates.

But the data shows that very high federal marginal income tax rates from 91 percent to 68.8 percent did exist from 1952 to 1981.

President Obama has proposed for 2013, a 39.6 percent marginal tax rate for those households with incomes of $388,350 and over, according to the Wall Street Journal.

In 2009, 22,000 millionaires paid only 15 percent of their income in income taxes. SSG does recognize that high tax rates on the rich produce behavioral responses that include actions like reducing hours of work, career choices, timing of compensation or accepting non-taxable compensation, tax avoidance or tax evasion. However, SSG contends that for most rich people, where behavioral responses are concentrated, responses to higher individual income tax rates include a shift away from taxable individual income to other forms of income such as corporate income, deferred compensation that is taxable at a later date, stock options and dividends.

SSG also claims that estimates are affected by the tax system that allows different rates for capital gains and dividends, and a host of deductions and tax credits.

Even with the current complicated tax system, the primary message from the study is that increasing the top tax rate, as President Obama is proposing, will not be detrimental to the economy and will increase tax revenues.

There is no doubt that the current tax system would be much better for the economy if many tax deductions, credits and other loopholes are substantially reduced. In addition, increasing tax rates on capital gains and dividends (constituting a large fraction of income of the rich), combined with substantially reduced corporate income tax rates, will provide a significant boost to businesses and the economy. Our tax/expenditure system has become skewed in favor of the rich and wealthy and does not much encourage human and physical capital accumulation and R&D; its effect also shows up in the skewed distribution of income.

SSG data show that since 1981 marginal tax rate on the top 1 percent has declined substantially, and precisely at that time their income share has started increasing dramatically. Tax Policy Center data show that in 2008 only 59 percent of the top 400 adjusted gross income (AGI) taxpayers paid the marginal tax rate of 35 percent and over and none paid effective average tax rate of 35 percent and over. SSG admits that inequality of income between the rich and non-rich may not be due only to the tax system.

However, starting in 1986 the sharp drop in marginal income tax rate on the top 1 percent accompanies the dramatic jump in their income share. At the same time, the next 9 percent in the income distribution, who also got a tax break starting in 1981, only gained a modest increase in income share. It is hoped that Americans pay attention to objective facts on taxes and about our current tax system and not be persuaded by empty rhetoric on the right based on ideology, emotions and twisted facts.

Mathur is former chairman and professor of economics and now professor emeritus, Department of Economics, Cleveland State University, Cleveland, Ohio. He blogs for the Standard-Examiner at http://blogs.standard.net/economics-etc/