Sanders's Tax Proposal Would Test a Hypothesis ; Rate for Highest Earners Could Eventually Lead to Less Revenue, Not More

By Barro, Josh | International New York Times, February 10, 2016 | Go to article overview

Sanders's Tax Proposal Would Test a Hypothesis ; Rate for Highest Earners Could Eventually Lead to Less Revenue, Not More


Barro, Josh, International New York Times


Combined taxes on the highest earners would reach or pass the point at which higher rates mean less revenue, which could make tax receipts disappointing.

In the Democratic presidential primary, Bernie Sanders is calling for a political revolution, saying his movement can sweep in policy changes that would seem impossible in traditional American politics.

One of the ideas Mr. Sanders has advanced is more revolutionary than it looks at first glance: much higher taxes on the highest earners, so high they would reach or even pass the point after which higher tax rates mean less revenue instead of more.

Mr. Sanders has proposed a top tax rate of 52 percent, applying only to incomes over $10 million. But that's just the federal income tax. When you combine it with other taxes that apply to income, like existing payroll taxes and new ones Mr. Sanders would impose to pay for Social Security, single-payer health care and family leave, and then add those on top of taxes levied by state governments, it would add up to a combined tax rate of over 73 percent on the highest incomes, more than 20 points higher than today. That's in the average state -- maximum rates in high-tax jurisdictions like California and New York City would be even higher.

It just so happens that in 2011, the economists Peter Diamond of M.I.T. and Emmanuel Saez of the University of California, Berkeley, drew attention with a paper estimating that the revenue-maximizing income tax rate on high earners -- the combined state and federal rate after which further tax increases would actually cause revenue to fall -- is 73 percent.

Mr. Saez, who is perhaps best known by the public for his work with Thomas Piketty on rising income inequality, said a key effect of such a large tax increase would be to push down the pretax incomes of the ultrarich.

"My feel is that the reasoning behind Sanders's tax plan is not so much tax revenue generation from top earners but rather make top tax rates so high so as to discourage 'greed,' defined broadly as extracting income at the expense of the rest of the economy as opposed to real productive behavior," Mr. Saez wrote in an email. "I think pretax top incomes would finally start to decline."

Mr. Sanders's 73 percent rate would apply only to ordinary income and only to people making over $10 million a year, which is not very many people. But even for what you might call garden-variety rich people, Mr. Sanders's plan would push rates near the revenue maximizing level: His plan would result in an all-in tax rate of just over 65 percent on income between $500,000 and $2 million.

Many supporters of Mr. Sanders would probably find this to be a desirable outcome, but there is a problem -- Mr. Sanders is counting on those high incomes to generate the high tax receipts needed to fund his single-payer health plan.

"We do not assume taxpayers change their behavior," said Warren Gunnels, the policy director for the senator's campaign. He said the tax rates under the plan were not chosen with an eye toward the Diamond-Saez hypothesis, but rather to generate sufficient revenue to pay for the senator's policy proposals. He said the plan assumes that new, higher rates would be applied to the existing income base, without taxpayers reporting lower incomes.

Much higher tax rates on the highest earners can generate revenue to pay for new programs, and they can encourage a more equal distribution of pretax income. But these two objectives are in tension with each other -- the more Mr. Saez is right that high rates will discourage ultrahigh incomes, the less revenue Mr. Sanders will get from his new taxes on ultrahigh earners.

Like much research about the interaction between taxes and the economy, theories about the revenue-maximizing tax rate are subject to high levels of both controversy and uncertainty. Some claims can be identified as clearly wrong -- see, for example, the Tax Foundation's claim that large across-the-board tax cuts proposed by Marco Rubio would cause revenues to be higher within a decade -- but the range of possibly correct answers about what tax changes will do to pretax incomes remains large. …

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