Summary: A new paper analyzes top tax rates for Americans, and concludes that a higher tax rate for the wealthiest citizens would benefit the entire country.
The Huffington Post reports that a new working paper drafted by Fabian Kindermann from the University of Bonn and Dirk Krueger from the University of Pennsylvania implies that the United States would be much better off financially if the tax rates for the richest Americans reverted back to Eisenhower-period levels. During Eisenhower’s presidency, the top federal income tax rate was a whopping 91 percent.
According to Krueger, the top tax rate that benefits all citizens, including the top 1 percent, is “somewhere between 85 and 90 percent.” The current tax rates are 39.6 percent paid on individual income above $406,750 and on income above $457,600 for couples.
Less than 1 percent of the American population has income in the top brackets. This translates to roughly 1.3 million people.
The tax increases do not mean that you’ll pay $405,000 of your $450,000 income to the government. A marginal tax rate is the amount paid on income above a certain amount. This means that you would pay the top marginal tax rate for the amount earned over $406,750. For example, if you make $450,000 per year, you pay the top tax rate on the final $43,250 in income.
During President Kennedy’s tenure, a different trend began. Kennedy implemented tax cuts for the highest earners in hopes that the economy would see a benefit. Kennedy offered tax cuts when the economy was in good condition, after it was no longer burdened by the expenses of World War II. Rates were cut to about 70 percent, a figure that would make today’s citizens panic. When Reagan was elected, taxes dropped even further to around 30 percent.
Later presidents raised taxes by historically minimal amounts. Presidents George H.W. Bush, Bill Clinton, and Barack Obama each raised taxes. Obama proposed raising taxes on families earning in excess of $250,000 by 3 percent to 36 percent, and on individuals earning over $200,000 from 36 percent to 39.6 percent. Both measures failed in the House.
Kindermann and Krueger note that such a tax rate is ineffective if it is burdened by loopholes. They add that the paper centers on income as opposed to wealth. Returns on wealth are how the superrich make their livings.
However, Kindermann and Krueger explain that a top marginal tax rate would decrease wealth and income inequality. In addition, more money would be brought in for the government, which would increase all citizens’ standard of living—even those who are taxed at the top rate.
Krueger stated, “High marginal tax rates provide social insurance against not making it into the 1 percent.” This means that there’s a small chance of making it to the top tax bracket. Therefore, if rates are high for the highest earners and low for the rest of the country, there’s a greater chance that you’ll pay lower rates. With these odds, he believes it makes sense to accept higher tax rates for the wealthiest citizens.
For lower income citizens, they’ll pay significantly less in taxes: “Everyone who is below four times median income (around $210,000 for a household) pays less,” Krueger explained.
The authors of the paper assume that higher tax rates will not hurt entrepreneurs in their ventures. What it does state is that the labor supply among the highest earners would decline, meaning these earners would work a bit less, however, the labor supply would “not collapse.” The authors assume that entrepreneurs, star athletes, and Hollywood kings and queens make up the top income bracket. What does this group have in common? Their talents are very rewarding financially, but usually just for a short blip of time. They have a few years to earn the highest income they will make for the rest of their lives. Therefore, a higher tax rate does not hurt their drive for success.
Krueger explained the system: “How much less would LeBron James play basketball if he were taxed at a much higher rate? The answer is not much. James knows he only has five years [of peak earning potential].” Therefore, the basketball star will work as much as he can to make as much money as possible during those few years. If the high rates robbed the wealthy of their drive to earn money, the paper would draw different conclusions.
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