Why 'Tax The Rich' Doesn't Solve Anything: It's The Math, Stupid
While watching the political conventions over the past couple of weeks, JPMorgan's Michael Cembalest wonders aloud: What if, something like the CBO’s Alternative Case scenario came to pass; debt markets were no longer willing to fund trillion dollar deficits, so the deficit had to be reduced to 3% of GDP by 2020; taxing the rich was the only thing the country could agree on doing? If this happened, how high would top marginal Federal income tax rates have to go? The answer, after some number-crunching: 71% for the top bracket, and 57% for the second highest bracket. Adding state, local, and payroll taxes, and in 'Blue' states like NY and CA, income taxes will approach 80%.
This is not a projection, but an illustration that there are not enough Americans subject to the top brackets to reduce the deficit to 3%.
Eventually, the US will more likely have to adopt broader-reaching tax reform (e.g., raising taxes on the middle class), larger spending cuts than those already adopted, and/or Federal Reserve monetization of the public debt.
Another option: a set of pro-growth policies that solve the problem by ramping up the denominator. The challenge: under the CBO Alternative Case, real GDP growth would have to average 8.6% per year (rather than the 2.9% that is currently assumed) to get the deficit to 3% by 2020.
After seeing what has happened in Europe, it seems likely that debt monetization would be a part of a US solution (in addition of course to the $1.7 trillion in Treasury bonds the Fed already owns).
One more thing on taxation. There was a lot of discussion around both conventions about the progressivity of the tax code.
The charts below show some history on effective tax rates by bracket, from the CBO. The first table shows income tax rates...
Note: effective income tax rates for the bottom two quintiles are actually negative due to the value of transfers and tax credits.
the second shows total Federal tax rates (including payroll and excise taxes).
Progressivity, apparently, is in the eye of the beholder. To me, the tables suggest a substantial increase in progressivity since 1979.
Before anyone says, “well, tax rates used to be that high”, consider the details. Marginal tax rates were 80%+ in the 1950’s, but applied to the mega-wealthy (income of $3 million+ in today’s dollars), rather than the $388,350 that marks today’s top bracket. In other words, people had to be 10x wealthier in the 1950’s to be subject to ultrahigh marginal rates. There were also more deductions then. For example, in 1979, while the top statutory income tax rate was 70%, the effective tax rate for the top 1% was less than 25%.
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