The 70 Percent Solution: What Are Taxes For?

(Bloomberg Opinion) -- Representative Alexandria Ocasio-Cortez’s proposal to tax income above $10 million at 70 percent has generated a lot of debate. In Bloomberg Opinion, Noah Smith has argued that it’s a mainstream idea well worth discussing, while Tyler Cowen has contended that any talk of raising taxes only helps Donald Trump. But what about its effect on the economy? On government programs? On actual taxpayers? Joined by their colleagues Karl Smith and Michael Strain, Noah and Tyler continue the discussion below.

Michael Strain: I’d like to set aside the politics of Ocasio-Cortez’s proposal and look at the practical economic impact. The most prominent recent research comes from economists Peter Diamond and Emmanuel Saez, who argue for a much higher top rate. But things can get tricky when applying the findings of economic research to real life. For example, if the government will take 70 cents of every dollar you earn above a certain income threshold, why go to college? The threshold obviously matters, of course, but the basic point about the decision to acquire advanced skills remains.

A 70 percent top rate could negatively affect the careers people choose. A young person interested in health care might decide to become a nurse rather than a surgeon, because much of the income gained from being a surgeon will be taken by the government. There is nothing wrong with being a nurse, and being a surgeon is not better than being a nurse in a normative sense. But in this case, our hypothetical young person isn’t deciding to be a nurse because that’s her preference — instead, she’s making the decision because the top rate is so high. This sort of tax-driven inefficiency makes society worse off.

There is not much empirical evidence on how important these longer-term considerations are, because sorting through the drivers of educational and occupational choice is very difficult. But just because economists can’t assign a magnitude to these effects does not mean that real-world tax policy should assume they aren’t important.

Tyler Cowen: Another perverse effect: A 70 percent rate is likely to cause lots of distortions as people shift income into less heavily taxed forms. And the more the discussion centers around taxes, the more that helps Donald Trump, who is viewed as the more credibly low-tax candidate (yes, Americans still don’t like high taxes).

Noah, you admit in your column that Ocasio-Cortez’s plan won’t raise much revenue or much reduce inequality — so why do it? Besides, Paul Krugman has declared (again) that big fiscal deficits aren’t such a problem, so what is the hurry? Do you think he is wrong? Why not just wait and see if interest rates rise to problematic levels? More broadly, the focus should be on designing a 21st-century tax system that can jump-start innovation in the U.S. once again. Surely that is not going to require confiscatory rates for some of the most creative Americans.

Karl Smith: I agree that Ocasio-Cortez’s proposal is unlikely to raise much revenue but instead to encourage the proliferation of tax avoidance-schemes. What worries me more, however, is the gathering storm of populist sentiment that infects the right as well as the left.

Consider that Ann Coulter has not only endorsed Ocasio-Cortez’s idea but doubled down on it, suggesting it be applied not just to income but to wealth. Meanwhile, on Fox News, Tucker Carlson delivered a scathing monologue about the dangers of market capitalism.

Americans may think that economic gains are too concentrated, with pockets of prosperity on the coasts and in some urban areas. But compare the U.S. to continental Europe. Europe’s prosperity rests almost entirely on countries and regions (Germany, northern Italy, metropolitan Paris) that have been centers of commercial development for centuries. There are no new clusters of dynamism.

In the U.S., newly competitive regions (North Carolina, Texas, Utah) are constantly emerging. There are many reasons for this, of course. A truly populist platform, instead of focusing on “soaking the rich,” would be looking for ways to encourage and sustain this kind of geographic vitality.

Noah Smith: First of all, let’s be clear that Ocasio-Cortez’s proposal would only apply to income above $10 million. So it would affect an extremely small number of people. It would raise little revenue and do very little to reduce inequality.

Her proposal, which would make the tax structure similar to the one the U.S. had in 1921, is pretty much symbolic — a way of expressing disapproval of inequality, while kicking off a lively discussion of income taxes and redistribution. On the other hand, raising taxes to 70 percent on income above, say, $300,000 a year — as Diamond and Saez proposed — would be an entirely different animal. It would raise lots of revenue, but it would also run the risk of many of the economic harms that Michael and Tyler describe. So let’s be clear about which of these ideas we’re talking about.

Ultimately, the question is whether we want to make the tax system more progressive — whether the risks of discouraging entrepreneurship, innovation and entry into high-value careers outweigh the opportunities to make life better for the vast numbers of poor and working-class Americans who have been hammered for decades by wage stagnation, the Great Recession and the China Shock. I think that there is definitely scope for significantly more redistribution, even though the costs are real.

Karl: Noah isn’t the only commentator who has pointed to Diamond and Saez to support rates as high as 70 percent. So it’s worth taking a moment to understand what the research on taxation is actually saying. If all you care about is maximizing revenue, and you have the ability to completely eliminate loopholes, then rates as high as 70 percent or more make sense. If, on the other hand, you accept that even with the best reforms the tax system will have flaws, then the ideal redistributive system looks a lot more like what we have today.

Almost two decades ago, Jon Gruber and Emmanuel Saez wrote a paper that considered two potential models, both of which value the well-being of the poor far more than that of the middle class or affluent. One, which they call the “progressive liberal” model, calls for a marginal rate on higher earners of 49 percent. The other, which they call the “compassionate conservative” model, imposes a marginal tax rate on the highest earners of 18 percent. In other words: What makes these systems redistributive is not punitive tax rates on the rich, but broad-based taxes that are used to fund a universal basic income for everyone.

Michael: Noah, your comments imply that policymakers need to weigh the harm from collecting more tax revenue against the benefits from more redistribution. That’s a good way to think about this, of course. But I think we should be draw a distinction between making the tax system more progressive and making it more punitive. You describe Ocasio-Cortez’s proposal as being “pretty much symbolic.” I don’t like either the meaning or the message behind the symbol.

Tyler: There are plenty of better ways to improve the lot of poorer people than by instituting economic measures that we all seem to regard as ineffective and distortive. Improving education, limiting occupational licensure, and deregulating building in America’s most productive cities would be on the list, among other ideas. Are Ocasio-Cortez and other Democrats doing America a service by focusing so much attention on a misguided tax proposal? The answer is a simple no.

Noah: The most important thing we need to be spending more money on is the transition to green energy. Ocasio-Cortez has laid out an ambitious plan to replace most fossil-fuel energy with carbon-free sources by 2030, called the Green New Deal. Upgrading the electrical grid to compensate for the intermittency of solar and wind, building electric vehicle charging stations, decommissioning coal plants and replacing them with wind and solar — it will all require a lot of money and resources. But in the end it’ll be worth it, not just for fighting climate change but for the country’s technological and infrastructure future. That seems like something that Tyler would endorse, given the focus on growth, technology, and environmental protection in his new book, “Stubborn Attachments.” So that’s what we need to be raising tax revenues in order to fund.

Redistribution is also an important goal. It’s not quite right to say that Diamond and Saez care only about maximizing revenue; what they care about is welfare. They assume that a dollar matters more to a poor person than to a rich person, so they assume redistribution is good.  As inequality has risen, more and more Americans have taken a similar perspective. It’s not clear that the public is going to be satisfied with more education, or tweaks such as limitations on occupational licensing.

It is clear that inequality is something the American people care about, and that some kind of redistribution is coming sooner or later. The goal should be to try to direct that popular energy toward productive policies that reduce economic activity as little as possible. And given the evidence, income tax reform seems one of the safest such policies available.

To contact the editor responsible for this story: Michael Newman at mnewman43@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Tyler Cowen is a Bloomberg Opinion columnist. He is a professor of economics at George Mason University and writes for the blog Marginal Revolution. His books include “The Complacent Class: The Self-Defeating Quest for the American Dream.”

Karl W. Smith is a senior fellow at the Niskanen Center and founder of the blog Modeled Behavior.

Noah Smith is a Bloomberg Opinion columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.

Michael R. Strain is a Bloomberg Opinion columnist. He is director of economic policy studies and resident scholar at the American Enterprise Institute. He is the editor of “The U.S. Labor Market: Questions and Challenges for Public Policy.”

©2019 Bloomberg L.P.