John Maggs asks if the higher tax burden on the top 1 or 2 percent of earners is efficient? Both liberal and conservative economists agree that it is not. Liberals authored the Bradley-Gephardt progressive income tax, which is based on lower tax rates in exchange for eliminating so-called tax loopholes.   They knew that high marginal rates were inefficient and often focused attention more on tax avoidance than productive economic activity. Many conservatives on the other hand favor a consumption tax base in lieu of an income tax. They too favor lower marginal rates but on a consumption basis.

To Maggs second question, is it fair? Fairness is in the eye of the beholder. A post-G20 quote from President Obama back in April still sticks with me today. He said, “I strongly believe in a free-market system…people don't resent the rich; they want to be rich. And that's good.” There is an important cultural difference between the U.S. and Europeans and it is central to contributing to our sense of entrepreneurship. That spirit should not be punished.

Finally, Maggs asks what will be the impact on recovery and growth? Most economists agree that higher taxes are the last thing we need in an economic downturn. These sentiments are well stated by Jared Polis, a young freshman Democrat who organized 21 freshmen and one sophomore in opposition, saying in a letter to Speaker Pelosi, "Especially in a recession, we need to make sure not to kill the goose that will lay the golden eggs of our recovery." Polis knows of what he speaks as a successful entrepreneur himself. While attending Princeton University he co-founded his first company, American Information Systems. He has since launched several successful business ventures, including: bluemountainarts.com, Proflowers.com and other online start-ups.

In his book, Great Contemporaries, Winston Churchill advised his friend Franklin Delano Roosevelt on the danger of “hunting down rich men as if they were noxious beasts. It is a very attractive sport, and once it gets started quite a lot of people everywhere are found ready to join in the chase. But, the quarry is at once swift and crafty, and therefore elusive.  The pursuit is long and exciting, and everyone’s blood is infected with its ardour.   … [But] far from depriving ordinary people of their earnings, [the rich man] launches enterprise and carries it through, raises values and he expands that credit without which on a vast scale no fuller economic life can be opened to the millions. To hunt wealth is not to capture commonwealth.”

The president is also right that there is a compelling argument for more progressivity in the tax system.  As Belle noted, the income distribution has become much more skewed over the last few decades. According to the CBO, the share of after-tax income going to the top one percent of households more than doubled between 1979 and 2005. Yes, they are paying a larger share of the taxes, but their share of income is growing even faster. I believe that it would be desirable and feasible for them to pay a larger share.

But the best way to do that would be to broaden the tax base. Raising tax rates entails economic costs and encourages wasteful tax avoidance and evasion. Moreover, we'll never get our budget problems under control by just taxing the rich. The president's pledge to exempt middle-income families from the cost of any new government spending guarantees that our giant deficits will just grow larger.

Moreover, the surtax deserves special scorn. Admittedly, Greg Leiserson and I proposed a similar (but smaller) surtax as a replacement for the AMT, but our idea was to replace an incredibly inefficient, stupid, alternative tax with a much simpler, slightly less inefficient, and slightly less stupid alternative. The problem with the surtax – just like the AMT – is that it grossly mismeasures income in some cases because it disallows legitimate deductions from income. At a rate of one or two percent, the damage might be tolerable, but at rates above five percent, it could do real damage. Moreover, if we use the surtax to pay for healthcare, we won't have the money to pay for eliminating the AMT. We'll just have added one more stupid tax to our already broken system.
 

With regard to arguments that higher taxes on the wealthy limit growth, the evidence is at best mixed and in fact is tilted much more to the conclusion that it does not lmit growth.  The evidence has long shown that higher tax rates don't affect work output of men.  But now it appears that they don't negatively affect work output of women. For example, in a recent CBO working paper, Kim and Rodríguez-Pueblita found that higher taxes lead married women to work more, not less. And this effect is stronger for younger women born after 1950.

And as Bell Sawhill notes, there is no historical relationship between top marginal rates and economic growth.  From 1870 to 1912 the United States had no income tax and federal tax revenues were just 3 percent of GDP.  From 1947 to 1999 the highest income tax rate averaged 66 percent, the government collected estate taxes and corporate taxes and federal tax revenues were at about 18 percent of GDP. Yet, growth rates of real GDP per capita were the same.  Likewise, cross national comparisions show no evidence that higher taxes on individuals negatively affect growth.  As Joel Slemrod notes “sophisticated statistical analysis of the relationship between economic growth and the level of taxation, which attempt to hold constant the impact of other determinants of growth to isolate the tax effect, have come to no consensus."

So while it's possible that very high marginal tax rates might negatively affect growth, at the levels being considered by the Obama administration and Congress, the impact on the economy will be zero. 

The area where taxes do matter is on the corporate side.  Relatively high U.S. corporate tax rates do hurt U.S. competitiveness and domestic investment.   Cutting those, particulalry in a way that spurs investment in the building blocks of growth -- research and development, new capital equipment and workforce training, will be critical going forward.  But raising the top marginal tax rate on personal incomes is a social and budget policy issue, not an economic policy one.

IRS data indicate that taxpayers with adjusted gross income (AGI) in the top 1% of the population bore 39% of the total national income tax burden, while those in the top 5%, 10%, 25%, and 50% bore 60%, 70%, 86%, and 97%, respectively, of that burden. Those in the bottom 50% paid a mere 3% proving the steep progressivity of the federal income tax system.

Although all taxpayers have seen a drop in their effective federal tax rate over the last 26 years, who has seen the greatest decrease? CBO numbers reveal that the bottom 20% has seen a 46% decline in their effective federal tax rates. Likewise, the second and middle quintiles saw a decrease of 31% and 24%, respectively. The upper middle class? Their effective federal tax rates decreased only 18%. And the top 20% of income earners? A drop of just 7%.

What about the Bush tax cuts? Since 2000, when Bush entered office, the share of federal tax liabilities borne by the lowest and middle quintiles has decreased, while the share borne by the highest quintile has increased. In 2000, the lowest quintile bore 1.1% of total federal tax liabilities compared with 0.9% in 2004, the year that all of the Bush tax cuts were in effect. Thus, the federal tax liability of the lowest quintile dropped 18%. However, the highest quintile paid 67.2% of these liabilities in 2004, an increase of 1% in their liability since 2000, when they paid 66.6%. These numbers don’t comport with the notion that the Bush tax breaks favor the wealthy; instead, they suggest that the wealthy are bearing more of the tax burden.

We have a steeply progressive tax system. Second, over time, the lower and middle classes—not the wealthy—have benefitted most from tax.

A so-called surtax will lead to a top marginal rate approaching 45 percent, depending on how the final version is structured since under President Obama’s budget plan the top tax brackets are already set in 2011 to revert back to the Clinton-era 36 percent and 39.6 percent rates.

At the same time, 55 percent of the revenue that would be obtained through the surtax plan would come from small business owners' "flow-through" income, or income from S-corporations, limited liability corporations and partnerships; the very companies that are the engines of job creation. The surcharge, combined with state taxes, could result in many successful small businesses being taxed at over 50 percent.

While the Ways and Means Committee states that the proposed surcharge will only impact 4.1 percent of small businesses, the Internal Revenue Service's 2002 Statistics of Income show that 64 percent of households filing individual tax forms with AGI (Adjusted Gross Income) above $250,000 filed as an S-Corporation or partnership or filed a Schedule C sole proprietor tax form. In addition of all small businesses, 75 percent are S-Corporations where the business income is passed through to the businesses owners' individual tax return, increasing the chances that these small firms will be negatively impacted by the proposed surcharge - the very kind of business that should lead in creating new jobs and help us emerge from this recession -- will be taxed at over 50 percent.

The House bill’s surtax tax increases would make U.S. tax rates higher even than most European nations. A huge new income surtax displays a reckless disregard for economic and fiscal reality.

There are two abiding, grievous weaknesses to the liberal “soak-the-rich” mindset and its many variants.  The first is that those so afflicted cannot bring themselves to admit these policies cause material, lasting harm to job growth and wages.  With an unemployment about to push through 10 percent, to even suggest higher income tax rates at this time for whatever purpose can only be described as self-delusional.  

The basic mindset does not just arise in tax policy.  It’s widespread.  For example, Secretary of State Clinton told the Indian government they could impose binding limits on carbon dioxide emissions without inflicting lasting injury to their economy.   I have no doubt Secretary Clinton has convinced herself of this.  Thankfully, in defense of millions of impoverished countrymen the Indian environmental minister remains unconvinced and unrestrained by America’s political correctness effectively told Secretary Clinton to bug off.

The second weakness in the “soak-the-rich” fairness theology is that the left has largely already won this battle, but the left doesn’t know how to declare their victory and shift talking points.  In truth, where would they go? 

However defined, the rich already pay most of the tax in part because of their relatively high tax rates and in part because so many low-income citizens either pay no tax or are actually receiving tax system-based welfare checks. 

Suggesting that the rich “can pay a little bit more” in President Obama’s words might be defensible if the rich did not already carry most of the load.  But year after year, proposal after proposal of “a little bit more” and we’re long past the point at which the rich are paying a whole lot more.  In addition, the President’s budget calls for an increase in the top individual income tax rate to 39.6%.  And he would bring back the old phaseouts of personal exemptions and itemized deductions.  And then he would add a specific new limit on the deductions for charitable contributions and home mortgages.  And the House health care bill proposals a series of surtaxes on upper-income taxpayers.  A little bit more?  Where’s an Indian environmental minister when you need him?

On the other hand, the President has a long list of ideas in his budget to turn the tax system further into a welfare system for low-income workers:  Make Work Pay tax credit; expanded Earned Income tax credit; expanded refundability of the child tax credit; expanded Saver’s tax credit; provide American Opportunity tax credit.  Altogether, the President and his allies are proposing a radical increase in the progressivity of the federal tax and transfer system

The way to improve fairness in America is not by taking more from the successful to make the poor more dependent on government.  The way to improve fairness is to strengthen the economy to create an environment of prosperity.  This requires measures that actually comport with basic economics rather than wishful fantasies.  Then we need to ensure that everyone who is willing to work toward self-reliance, self-respect and prosperity has that opportunity. 

It is bad economic policy because, coupled with the scheduled expiration of the Bush tax cuts, it would raise marginal tax rates by 10 percentage points for high-income households. While I object to the general hue and cry that occurs anytime anyone discusses any potential tax increase for the rich, it is nevertheless quite fair to say that a 10 percentage point increase in taxation on the return to labor and capital income is a lot and shouldn’t be the first choice.  (But please spare me the small business arguments.)

It is bad health policy because we need to fix the structural problems in health care in order to cut costs and be able to expand coverage. One of the biggest structural problems is the non-taxation of employer-provided health care. Fixing that – converting it to a refundable fixed credit a la Furman and McCain – would not only raise a lot of money, it would improve incentives for health care.  Taxing the rich does not address this issue at all – it may raise the same amount of revenue but it does not address the incentive problem that arises from nontaxation of employer provided health care.

It is bad budget policy because we are using up one of our options on the revenue side not to cut the deficit but to finance new spending. We need to save our powder for deficit reduction activities – use the change in tax treatment of employer sponsored health care to finance health care and use general revenue increases to finance general deficit reductions.

It is poor leadership because it furthers the myth that we can solve our fiscal problems by taxing “other” people or with gimmick taxes.  It has been said many times already and will be said many times again:  we are going to need broad based tax increases and spending cuts to bring the fiscal house into order and the more politicians continue to act as if we can just foist the financing on a small group (be it rich people or foreign corporations or obese people or people who drink soda, etc.) the worse are our prospects for solving the problems. 

Even if one wants to argue that the rich should bear a larger burden of federal taxes and claim that such a policy is efficient (under the assumption that we are not at the optimal level of redistribution which is a public good in itself), there are better ways to redistribute from upper-income Americans than the Democrats appear set to do.

Obama ridiculed Sen. McCain in the campaign for proposing to tax employer-provided health insurance, but such a revenue raiser is far better than a surtax. Even partially taxing it (above some threshold) would be a good start as opposed to the surtax.

Furthermore, the Democrats in Congress are giving away so much in cap-and-trade permits that will accrue as benefits to owners of capital (largely high-income people) that not doing so could raise an amount of revenue in excess of the surtax. If cap-and-trade is going to happen, then why not in the process raise some revenue in a way that is not going to harm economic efficiency?

But I guess this takes us all back, however, to a broader economic model of public finance, which does not start from the social welfare maximand approach, but rather takes into account policial realities (i.e. essentially public choice). In such a world, we are not just faced with questions of second-best relative to the social welfare maximand approach, but even third, fourth, fifth, and sixth bests.

And on that, all I can say is that even if you believe greater redistribution from the rich is good public policy (in general), the way in which it is being proposed (just raising marginal rates) significantly reduces the probability that it truly is welfare-enhancing.