Radicalism has arrived at the centre of US tax policy. Alexandria Ocasio-Cortez, the mercurial New York congresswoman, recently proposed a 70% marginal tax rate on incomes over $10 million a year to fund green programmes. And taxing the rich is popular. Reuters found that three quarters of Americans support the idea. But is 70% too much for freedom-loving Americans? No, according to one poll 38.7% support the idea versus 34.4% who oppose it. Not surprisingly, asking someone else to pay more is proving an easy sell.
Proponents of the 70% not only shriek the usual soundbites about millionaires and billionaires ‘paying their fair share’ (which always means more than they are currently paying) but also claims that 70% is not that extreme and is indeed perfectly possible. They point to Sweden, where today high incomes are taxed at around 70%. They point to the Eisenhower administration, where tax rates reached more than 90%. If people mention the lacklustre economic growth during that administration, they point to subsequent Democratic presidents who presided over strong growth and slightly lower, but still very high marginal tax rates. And the US wasn’t the only country who experimented with extortionate taxes. In the UK, marginal rates were as high as around 90% during the 50’s and 60s and was only reduced from over 80% when the Thatcher government came to power in 1979.
It is a well-known counter argument that a complicated tax code with multiple loopholes meant that few paid the very high marginal tax rates prevalent in the US before the Regan administration simplified the tax code and implemented steep tax cuts, based in part on faith in the so-called Laffer curve.
But what about Sweden? Accounting for payroll, local and state taxes it is indeed true that take-home pay can be as little as 30% for high incomes. Denmark has a similarly high marginal rate and Norway is not far behind. But a recent study estimates that the 1,000 richest families in Scandinavia avoid paying up to a third of their domestic taxes by moving money abroad, mostly to Switzerland. In a global economy, money can move freely, and they do.
But if the rich are moving their money abroad, who is paying for the famously bloated Scandinavian welfare states? Well, Sweden taxes incomes above approximately 1.5 times the average at nearly 60% – in the US, that would mean incomes above $90,000. The 70% rate is reached at an income around $100,000. The so-called tax-wedge, published by the OECD, calculates the total tax rate paid by someone earning the average wage including all employer contributions etc.
Source: OECD
Unsurprisingly, the average US worker pays far less tax than his Scandinavian counterpart. Paying for all those free goodies requires higher taxes on all, not token punitive rates for the rich – who tend to find ways around paying anyway.
There are obviously ways of preventing the wealthy from avoiding tax. When Eisenhower and his successors presided over those lofty rates, we were at the end of what was known as the Golden Age of Capitalism, the post 2nd World War economic expansion. It was also the twilight of The Bretton Woods system of exchange rates, finally abandoned in 1973, which committed members to maintaining exchange rates pegged to the US Dollar. But in what is known as the Impossible Trinity, members of a fixed exchange rate system must either give up independent monetary policy, like members countries of the Euro have done, or operate capital controls. Under Bretton Woods, members chose capital controls.
This may not worry proponents of 70% tax rates. The free global flow of capital has many enemies on the left, exactly because it allows international tax competition. But capital controls come at huge costs. Foreign investment drops as investors fear the consequences if they want to withdraw their money and domestic investors, including pension funds, suffer from less investment opportunities and therefore lower returns. In effect closing off an economy from the international flow of capital can have dire consequences, and these days capital controls are indeed mostly used as temporary measures during for example a currency crisis.
But the question is not only under which conditions it is possible to introduce a 70% marginal tax rate. It is whether it is counterproductive.
Firstly, the disincentive introduced by high taxes are clear and well understood – but how this manifests is not obvious. Sweden ranks below the US in GDP per person but higher than countries with lower tax burdens, like the UK. However, many other factors play in. Both Sweden and Denmark were, when the US and UK were experimenting with sky-high taxes in the middle of the last century, relative low tax economies. Over recent decades both have been dropping down the rankings of the richest countries in the world. Harder to quantify is intangible factors such as social cohesion, which in smaller societies help create the solidarity which smooths the way for high taxes. Also, a flatter tax structure, where lower incomes also suffer high tax rates, may lessen the hostility towards high marginal rates. Anyway, let’s not forget that the Scandinavian elite seemingly often don’t pay those high rates anyway.
Secondly, it is not clear whether such high marginal tax rates are revenue generating for the government. Much research does seem to indicate that the revenue maximizing tax rate is around the 70% mark, though some studies have it much lower. But empirical evidence points to potential pitfalls.
Recent experiences from Canada, where the top rate was increased from 29% to 33%, show how the dynamics can be unpredictable. The change failed to produce the C$3 billion revenue predicted. In fact, top earners paid C$4.6 billion less in tax in 2016, the first full year after implementation. This is probably more due to creative tax accounting than the demotivating effects of less marginal take-home pay. But the byzantine tax codes that have become standard across the world open up for this kind of creativity – and maybe it is the incentive to approach a good tax lawyer rather than the incentive to substitute spare time for work which increases most when tax rates go up. This is obviously a much more preferable dynamic, as economic activity is relatively unaffected – but the result for the public coffers are the same. One estimate suggests revenues from a 70% tax in the US could be as low as $12bn, 0.3% of total tax revenues. That won’t pay for many solar cells. Even if behaviour didn’t change, taxing current incomes over $10 million at 70% would only raise $72bn, an increase of federal tax revenues by around 2%. Handy, but hardly revolutionary.
At the end of the day, tax receipts only really matter if they act as limits on public spending. And that has not been the case in most Western economies for decades. US federal debt is over 105% of GDP and rising. But the 70% tax rate is proposed alongside the ludicrous Green New Deal which, inspired by the voodoo economics of New Monetary Theory (MMT), relies on deficit spending and not on tax receipts. As such, if tax receipts go up or down can seem rather academic.
Punitive taxation of the rich may satiate the enviousness and resentfulness permeating the left of politics, but the simplistic call for the rich to ‘pay their fair share’ hides a much more complex problem. It is highly questionable if it would work anything like intended and may work to erode any legitimacy the tax code enjoys. And though those of us who believe that all taxation is tantamount to theft may question the argument that confiscatory taxes crosses a moral line that hasn’t already been crossed, many would argue that the ‘social contract’ breaks when what the taxman demands and what the state offers you in return gets too out of whack. 70% tax may be bad for the economy and fail to raise the hoped-for revenues but many would add that it’s plain and simply wrong.