Tax experts are refuting a recent New York Times article claiming the current top tax rate of 39.6 percent is too low.
The article by David Leonhardt explains top marginal tax rates for the highest earners were once a high of 91 percent. Under Lyndon Johnson, the rate was lowered to 70 percent. Under Ronald Reagan it was lowered to 50 percent. The rate has ranged from 30 to 40 percent since 1987.
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"When [George] Romney said no to bonuses, the top marginal tax rate was 91 percent," Leonhardt wrote. "Even if he had accepted the bonuses, he would have kept only a sliver of them."
Not mentioned by Leonhardt is the fact that high-earners routinely used tax shelters and other means to avoid paying the top rate. In 1960, for example, only eight Americans paid the top rate of 91 percent, according to economist Larry Lindsey.
"A top rate of 90 percent clearly has the potential to drive away entrepreneurs," Leonhardt concedes. "But I am convinced that the current top tax rate, 39.6 percent, is too low."
Others are not so convinced. Adam Michel, a policy expert at the Heritage Foundation, says that analysis is incorrect and that incentives increase when top tax rates are lowered: "We do see in the data, time and time again, that when you lower top marginal tax rates, which is what he's talking about, it does increase individuals incentives to save, invest, work more and unleashes entrepreneurship and business creation in the economy."
In addition, experts say the top marginal tax rate of 39.6 percent isn't the full picture since there are more taxes on top earners.
Alan Viard, a resident scholar on tax policy at the American Enterprise Institute, explains that the top tax rate is really 43.4 percent: "For what it's worth the tax rate is actually higher than 39.6 percent for people at the top. There's also a 3.8 percent Medicare payroll tax that applies to wages earned by people in that bracket, and there's also a 3.8 percent net investment income tax that applies to interest, dividends, capital gains, and some other types of investment income."
"So that's really 43.4 when you add that in," Viard said. "Then of course there's also state income taxes in most states so the actual tax rate is already somewhat higher than 39.6."
John Cochrane, a senior fellow at the Hoover Institution, echoed that sentiment and said that the federal income tax shouldn’t be analyzed in isolation and that all taxes should be considered when calculating the economic damage. "39.6 percent is the top federal rate, but what matters to the economy is not just the federal income tax. It's the overall amount of taxes that get taken out of each extra dollar you earn." Cochrane explained that individuals pay not only the federal income tax, but state and local income taxes, payroll and sales taxes, capital gains and dividends, interest tax, and estate tax as well.
"What counts to the economic damage of taxes is not the federal income tax in isolation—it's the overall tax by every dollar," Cochrane said. "You start adding that up, and we're well past 39 percent already—depending on who you are, we're into the 60-80 percent top tax rate."
The Times article states that the top tax rate of 39.6 percent has contributed to inequality, while the rich have received tax cuts and pretax raises. "Plus, there is no evidence that a modestly higher rate would hurt the economy," Leonhardt writes. "The recent president with the strongest economic record, Bill Clinton, increased the rate, while the one with the weakest economic record, George W. Bush, cut it."
Michel, however, argues that "looking further back into history, that's not the trend that we see. We saw top marginal rates be cut in the 1920s, and we saw large economic expansion. We saw them cut again in the 1960s, again we saw a large economic expansion. We saw them cut again in the 1980s under Reagan, and we saw large economic expansion. So I think there's also other counterevidence to the point he's making there."
Viard says that deciding on a top marginal tax rate is seen as a value judgment and a tradeoff. If you were increasing the 39.6 percent rate and the size of government, Viard said he thought most economists would agree that would have some adverse effect on growth because it would reduce incentives to work and save, and it would magnify other distortions in the tax code that favor one sector of the economy.
Viard says there could potentially be the maximum possible economic growth if the top tax rate went to zero and only the essential services needed for the economy were paid. He says, however, this would be harsh to society and believes both sides of the political aisle agree there is a need for a social safety net.
"On the other hand if you raised the tax rate up to 70 or 90 percent, you could do a lot to reduce income inequality," Viard says. "Most economist believe you would be slowing the economy to a significant extent so it really is a tradeoff."
The Times article suggests that many of the rich turned down bonuses at a time of a high rate of 91 percent. Experts, however, argue that many Americans did not pay that high of a rate.
"Back in the era before the 1986 tax reform, the U.S. said we had high tax rates but in fact rich people didn’t pay a lot of taxes," said Cochrane. "What happened was in the old days, we'd pretend to have a very high tax rate and then of course there's this huge number of deductions, exemptions, and carve outs, and everybody has a tax lawyer, and they end up not paying that much in taxes anyway."
"The idea that people were paying 70 to 90 percent at all is wrong because everybody had tax shelters," he said. "The amount rich people were paying for federal income tax was way below the 70 and 90 percent official tax rates."
Viard agreed and said there was a strong incentive to shelter income when there were high marginal tax rates. "You certainly had a lot of people avoiding tax and very few people—nobody was really paying certainly 91 percent of their overall income because they were all sheltering a part of their income."
"I don’t think anybody would really want to go back to a system where we had a rate of 91 percent on some income but then many types of income were exempt entirely. That would just be a really inefficient system for sure," Viard said.