Federal income taxes went up last year, a financial reality becoming ever clearer to many higher-earning Americans as tax day looms. But how much higher can Washington clip wealthier Americans before rising tax rates really weigh on US economic growth?
Quite a bit, some would argue. Despite those tax hikes, the American economy actually grew faster in 2013 than in 2012. Real GDP — measured fourth quarter over fourth quarter — accelerated to 2.6% from 2.0%. Another point: while the current top tax rate of 39.6% is the highest since the 1990s, the economy has done just fine with top rates double that level. Real GDP grew by 3.6% annually in the 1950s even with a 91% top rate. Going forward, progressive economist and inequality researcher Thomas Piketty recommends a top rate of 80% in his new book “Capital in the Twenty-First Century,” a work much praised on the left. Clearly, then, tax rates could go a lot higher both to reduce income inequality and raise more dough for government spending programs, right?
Actually, it’s far from clear that we’re not already at Peak Tax, or at least near the summit. First, fiscal austerity last year was offset by monetary stimulus as the Federal Reserve embarked upon its bond-buying program.
Second, the top effective tax rate in the 1950s was closer to 50% because of tax loopholes in an economy experiencing some amazing one-off, postwar tailwinds. High-tax advocates like Piketty want to raise rates and get rid of loopholes, creating sky-high effective rates never before experienced in an advanced economy.
Third, high rates in states like California and New York mean “we might be pretty close to the revenue-maximizing tax rate,” Alan Auerbach, a center-left tax economist at the University of California, Berkeley, told the Wall Street Journal.
Fourth, estimates that sharply raising tax rates has little to no impact on taxpayer behavior completely ignore possible longer-term effects. What about all those folks who take risks and make career choices in hopes of striking it rich? “Significantly reducing that possibility by hitting those individuals with extremely high income taxes is of first-order importance in determining the optimal top tax rate,” AEI’s Aparna Mathur, Sita Slavov, and Michael Strain argued in a paper last year.
Fifth, it’s not the just the 1% bearing a large share of the income tax burden. Citing the CBO, the WSJ notes that “the increase in the individual income tax burden borne by the top 20%—such as couples with two children making more than $150,000—has gone from 65% in 1980 to more than 90% as of 2010.”
Given an aging society, the US in the future will need to collect more revenue than the postwar average of 17.4% of GDP. How much? Maybe at least a quarter more, and even that’s assuming smart entitlement reform. To do that without crippling growth, the US will need to shift from a progressive income tax to a progressive consumption tax. The US tax burden may be headed higher, but top income tax rates shouldn’t be.