Show Me The Money!

Jon Chait follows up his article on the gap between productivity and wages, with a published chat with Robert Rubin and Peter Orszag on the issue. The current issue of TAP, meanwhile, has a package of articles on policies to create high-wage jobs.

Let me just observe with regard to Rubin and Orszag that I feel like they're neglecting the possibility that tax rates influence pre-tax distribution. To take an extreme example for illustrative purposes, if you had a 90 percent tax bracket kick in for people making over $400,000 a year, it would make much more sense to try and hire two people each making $400,000 than to try and hire a "superstar" for $800,000. The additional $400,000 you'd be paying in salary to the superstar would only buy $40,000 worth of labor, which is a pretty crappy deal for the employer. Bush's cut in the top rate wasn't super-dramatic on that scale, but if you look at the long-term Carter-Reagan-Bush-Clinton-Bush trajectory, the top marginal income tax rate actually is way lower than it used to be.

Comments

Wingnut blog post from the near future:
"Left wing blogger Matt Yglesias endorses a 90% marginal tax rate"
Disclaimers like "for illustrative purposes" mean nothing to dishonest people.

Posted by SP | October 31, 2006 11:21 AM

My impression is that no one actually paid the top marginal rates back in the day. One of the big goals the 1986 Tax Reform Act was to make sure people who actually had an income in the top bracket actually paid the top bracket, or something close to it.

But yes, the point stands.

Posted by Nicholas Beaudrot | October 31, 2006 11:28 AM

No, actually, the point doesn't stand. There wasn't a tremendous amount of difference between the top rate then and the top rate now. Pre-'86, people lowered the nominal tax rate through endless loopholes and write-offs. '86 simplifed the tax code but did not tremendously change what people paid.

Posted by Cthomas | October 31, 2006 11:35 AM

I think one of the big parts of Reagan's '81 tax cut was to collapse the top 3 or 4 brackets into one, all at the lowest of those rates, around 50% or so. The fact that people were using various loopholes to get around the highest rates at that point, i.e. in excess of 50%, just supports the argument that there wasn't much reason for keeping the top rates that high.

Posted by Haggai | October 31, 2006 11:49 AM

Ah, what a nice surprise!

Cthomas, yours is an unusually verifiable assertion. You are hereby formally requested to verify that sucker. Please, I insist. Take those who in, say, 1959 were in the highest marginal bracket and compare them with those who were in the highest marginal bracket in 1999 (among them, me). Please prove that, dollar amounts adjusted for inflation of course, the federal taxes paid by the 1959 cohort, per capita, was no more than, say, 10% different than the 1999.

Posted by Keith M Ellis | October 31, 2006 11:50 AM

The fact that people were using various loopholes to get around the highest rates at that point, i.e. in excess of 50%, just supports the argument that there wasn't much reason for keeping the top rates that high.

Probably the top rates shouldn't be that high. It was, as I said, for illustrative purposes. The effect still exists, however, at the margin. Changing the top marginal rate from 31 percent (I think that's where it is) to something like 40 or 45 percent would make a difference, I contend, to the pre-tax distribution of income. The fact that investment income is very lightly taxed may also be relevant here.

Posted by Matthew Yglesias | October 31, 2006 11:55 AM

I, like Keith, would like to see evidence for Cthomas's claim. Recall that Bush likes to argue that his tax cut was good for middle class people because it lowered their taxes, and rich people don't pay taxes anyway thanks to all the loopholes. Win-win, if you believe the "rich don't pay taxes" argument (or the "rich pay constant taxes regardless of the tax code" argument).

Also, remember that accountants aren't free. If you reduce your tax burden by $10,000 but pay an accountant $9,000, the tax is still having a pretty big impact on you even if the government doesn't get the revenue.

Finally, remember that we're talking about marginal rates. A loophole that saves you a flat $5,000 doesn't reduce your marginal rate.

Posted by minderbender | October 31, 2006 12:00 PM

I hear a lot about these loopholes, and don't doubt that they existed, but can somebody tell me what they were?

Posted by chris | October 31, 2006 12:40 PM

The effective tax rate -- the total amount of what the Federal gov't actually hauls into their coffers -- has bobbed between a high of 20.9% of GDP (1944) and a low of 14.4 (1950) since the Feds became the modern Federal gov't at the end of WW2. Despite all the propaganda and hollaring and bellyaching the effective federal tax rate has stayed in that range pretty constantly. In Reagan's years, for example, the rate was (consecutively) 19.6, 19.1, 17.5, 17.4, 17.7, 17.5, 18.4, 18.1. During Clinton's years the rates were (consecutively) 17.6, 18.1, 18.5, 18.9, 19.3, 19.9, 20, and 20.6.

Smoke, mirrors, and malarkey.

Posted by Jeffrey Davis | October 31, 2006 12:50 PM

Yes, but that's not relevant to this discussion.

Posted by Keith M Ellis | October 31, 2006 1:06 PM

I think the commenters need to slow down and think a little more about how the tax structure works. 'Loopholes' don't do very much to reduce the marginal tax rate, they affect the average tax rate a lot more.

Simple example. $100,000 in income, $70,000 in basic allowance and 'loopholes', 50% tax rate. This tax payer will pay 15% of total income in taxes, but 50% at the margin.

Let's apply the Reagan 1986 deal - reducing allowances and rates. $100,000 in income, $40,000 in basic allowance and loopholes, 25% tax rate. This tax payer still pays 15% of total income, but the marginal rate is halved.

In this case, we're looking at a revenue-neutral change, but much stronger incentives to hire the super-stars that Matt is focusing on. They get to keep a lot more of what's left after the allowances are factored out.

And let's drop the loaded term 'loopholes'. With the exception of a few overly-complicated corporate shelters, we're really talking about a deliberately constructed inducement in the tax code to drive behavior. Whether those inducements are smart is something one needs to analyze in each specific case, but they are created with the intent that they be used.

Posted by Dan Ryan | October 31, 2006 2:22 PM

Wouldn't that depend on the elasticity of demand for different types of labor?

For example, suppose superstar CEOs were extremely valuable - if you don't have one, you go out of business. Then raising the tax rates on CEOs would just force companies to shell out even MORE money to keep the same CEOs, because inelastic labor demand would force the companies to pay most of the tax increase...meaning they'd have much less left over to pay their workers and would end up having to hire Chinese workers instead.

But if high-end labor demand is very elastic - if it's easy to replace a CEO with two cheaper people, as Matt suggests - then raising taxes would lower those high salaries, because the high-paid employees themselves would be bearing most of the cost of the tax.

So it all depends on how much companies need their top-earning employees. If top-earning employees aren't that essential, you very well might be able to equalize income by making taxes more progressive. But if top-earning employees are very essential, raising taxes on those employees could just make the income distribution more unequal.

Does that make sense, or am I out to lunch?

Posted by Mr. Noah | October 31, 2006 2:29 PM

I don't remember exactly what the top federal marginal rate is but I am pretty sure it is more than 31%.

Posted by James B. Shearer | October 31, 2006 2:40 PM

According to this table on the IRS website the top rate in 2005 was 35%. Note this is a nominal rate, the actual top marginal rate will be higher because of the exemption phase out.

Posted by James B. Shearer | October 31, 2006 2:52 PM

In some cities $400k is not a lot of money. It certainly doesn't make anyone rich; and, after mortgage, school tuition, property taxes, personal taxes, there isn't a ton of money. The best perk is being able to eat really high quality food and ordering a lot of take out, because, when you earn $400k a year, most of what you do is work. These aren't the people jetting off to Paris to see the fashion shows on weekends. The trend is that that the richest one percent of one percent are making the sloppy flithy money. Raising the taxes on them is where the money is.

Posted by Cal | October 31, 2006 3:19 PM

"The effective tax rate -- the total amount of what the Federal gov't actually hauls into their coffers -- has bobbed between a high of 20.9% of GDP (1944) and a low of 14.4 (1950) since the Feds became the modern Federal gov't at the end of WW2. Despite all the propaganda and hollaring and bellyaching the effective federal tax rate has stayed in that range pretty constantly. In Reagan's years, for example, the rate was (consecutively) 19.6, 19.1, 17.5, 17.4, 17.7, 17.5, 18.4, 18.1. During Clinton's years the rates were (consecutively) 17.6, 18.1, 18.5, 18.9, 19.3, 19.9, 20, and 20.6.

Smoke, mirrors, and malarkey."

Posted by: Jeffrey Davis

I'd like to point out that 1% of a $7 trillion GNP/GDP is $70 billion. Reagan's highest defict was a bit over $200 billion, IIRC, or 3% of the GNP/GDP. So the ammounts we're talking about are significant.

Trivia - this was the subject of a beautiful example of 'how to lie with graphs'in the WSJ Editorial page, way back when. They used a vertical scale of 0-100% of GDP, so 2-3% changes looked trivial.

Posted by Barry | October 31, 2006 4:21 PM

I actually emailed Greg Mankiw with this question and he agreed that it would come down to the elasticities...i.e. how much corporations can afford to replace those high-paid workers.

But then again, he did work for the Bush administration...

Posted by Mr. Noah | October 31, 2006 4:47 PM

Much as I would like to believe that the lack of wage growth could be fixed by raising tax rates on high incomes, it does not fit with the evidence. Much of the changes in the personal incomes of the rich represents a shifting of income from sheltered to unshelered. If instead you look look at the income of the non-rich, there is a slow steady decline of the GDP share since the mid 1970's, and a median wage that is unchanged after inflation adjustment. Look at the long time series graphs at

http://www.visualizingeconomics.com/category/graph/

The jumps in the incomes of the top 1 .1 and .01 % are not mirrored in the income of the everybody else as % of gdp, but is only seen in the % of reported income. What ever is wrong went wrong in the 70's. Given the timing, the suspects are the relativly high unemployment rates, tight fed policy, number worker entering the labor force, the increase in trade, or a combination of them. What it is not, is the returns to education, since the bottom 99% include most of the well educated, or benefits because health cost are not up enough so that the employers share can account for more than a small fraction.

Posted by joan | October 31, 2006 10:45 PM

400K not alot of money in some cities? Maybe if you are living in Tokyo, London or Zurich and getting paid in dollars. An income of 400K puts an American in the top 1%. Cal must be a left handed pitcher or an NBA power forward if he thinks pocketing $400,000 a year doesn't mean you are rich.

Posted by keeping up with the Andruw Joneses | November 1, 2006 4:54 AM

yglesias in comments:

to something like 40 or 45 percent would make a difference, I contend, to the pre-tax distribution of income.

I think that's going towards pushing it over the limit where you start to get diminishing returns in all kinds of ways, including income and compliance.

Bill Clinton held the top bracket steady at 39.6%. It was not chosen for the hell of it or at random. I recall that was carefully studied and applied from the first days before inauguration, trying to fulfill promise #1: "it's the economy, stupid." And one great effect was you rarely heard complaints about it being too high, people paid it happily as long as the budget got balanced and economic opportunity abounded. But don't believe me, do a little research on that yourself.

Also I think your argument is simplistic in that people pay things like state and city income taxes (check out New York City costs!) which often are "make-up" for low Fed taxes or Fed funding to the community in question.

I remember higher bracket days early in the Reagan years and seeing what the well-off people I interacted with in my work did to avoid paying: anything. One contingent that benefits greatly is accountants and tax attorneys, if you care about helping them.

Perhaps your idea, though, could go the way of thinking about what effect raising the income limit where SSI & FICA payments stop, raising it way higher. That's something that, for some reason, in my experience, well-off people do not equate with taxation by the Feds to be avoided, it's like it's "separate" in their mind. Maybe it's that they feel it's like paying for an actual service rather than into the grand maw of Federal corruption? (and when time comes to collect Medicare and SS, they rarely refuse it, piddling tho it may be. :-)) But remember, the employer pays a matching half--so many who have never been self-employed forget that.

Better yet, if you want challenging thought on the topic, think about taking it out of the relationship to income all together and going towards VAT. I am no big fan of that for many reasons, but it's certainly throws a completely different light. Is the fact that many countries that rely on it have high unemployment related?

BTW, I agree with those that mention that putting a figure of 90% tax rate into a post, even as a theoretical example, is a killer. You have more than a few start mentioning that figure, you will lose any upper class you may have in your political party; you enact it, you will actually lose citizens or at least any tax income from them or indeed any income from them into the economy at all. (I seem to recall reading that JFK had something to say about that all, an early version of Clintonomics as it were.) Ask any successful English rock star from the 60's or 70's. Or many bankers in certain small Caribbean countries. It's a very dangerous thing to say and may be misquoted for eternity.

Posted by artappraiser | November 1, 2006 7:46 PM