Scott Sumner  

Wait, did Bernie Sanders win the election?

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Per Capita Growth... Reminiscences of Rand and Buck...

Let's go back a couple years to see just how radically this country has changed. Jeb Bush is running for president, proposing a tax reform with a top marginal tax rate (MTR) of 28%. Marco Rubio is proposing a top rate of 35%, and that's viewed as being pretty mean to the rich:

A revised 15%/35% structure would likely leave everyone unhappy: Those who are currently taxed at the top rate of 39.6% (taxable income in excess of $413,200 if single, 464,850 if married jointly) will not be thrilled at their rate dropping a mere 4.6%, particularly when previous plans by Bowles-Simpson and Romney had proposed a top rate ranging from 25-28%.
So even the bipartisan Bowles-Simpson budget reform plan called for a much lower top rate.

The eventual GOP nominee (Trump) called for a top rate of 25%, far below the 43.4% top rate enacted by President Obama. After winning all the branches of government, you'd sort of expect the GOP to propose at least a token reduction in the top rate.

Now the Wall Street Journal reports that the GOP plans to raise the top federal income tax rate to 49.4%:

The House GOP's reform proposal for individual taxes is a mess, but now we learn it also includes a stealthy 45.6% marginal tax rate on some high earners. This dishonest surcharge betrays the GOP's purposes of growing the economy and simplifying the code, and Republicans ought to kill this gift to the left that will be slapped on more Americans when Democrats return to power.
[I added the additional 3.8% income tax to the regular income tax, something our media always forgets to do.]

Now let's consider a wealthy person in California. Under Obama that person faced a top rate of roughly 50%, combining state and federal incomes taxes. Under the new GOP plan, the top rate for Californians would soar to 62.7%, a rate one associates more with Thomas Piketty or Bernie Sanders, rather than the Ronald Reagan GOP. (The UK has a top rate of 45%, for instance.) Pinch me, is this really happening?

One of my commenters, who likes the proposed tax bill, specifically approved of the fact that it slashes taxes for businesses while raising them on high wage earners, which he suggested were largely "parasites". I think it's a silly to argue that business owners are somehow better than high wage earners, but let's say that this view is out there in America.

One thing that some commentators noticed about the past election was that lots of working class people identified more closely with populist billionaires than with highly educated professionals (who they regarded as snobs). Now the GOP is producing a tax plan that slashes the MTR for working class people and also for billionaires like Trump, while raising rates on very highly paid professionals. Coincidence?

We've had a lot of discussion of the fact that both the rich and the poor increasingly vote against their interests. Maybe not their actual interests, but against what intellectuals regard as their interests. One famous example is the book "What's the Matter with Kansas?". You could ask the same about the Upper East Side of Manhattan.

Consider this possibility. If people in California and New York keep voting Democratic, even though many would benefit from lower taxes on the rich, then eventually the GOP starts to write them off, and no longer legislates in ways that favor those groups. I wonder if this is starting to happen already.

In politics, things never stand still. When I was young, West Virginia was extremely Democratic and California was Republican. Given how these two states now vote, the GOP increasingly wants to "deregulate" industries like coal and "regulate" industries like high tech. The policies follow the voters, not the other way around.

What about the flip side of this? Will the Dems move in the other direction? I'm not sure, but it's clear that if they don't then highly paid professionals and tech firms are going to start getting hit from both directions, and their situation is likely to become much less pleasant.

In other words, maybe we are about to have two socialist parties, one leaning liberal and the other nationalistic.

PS. An article in Forbes denied the existence of this top rate increase. But after reading all five pages, all the author did is convince me that he doesn't understand the distinction between marginal and average tax rates.

PPS. This Tyler Cowen post on taxes is excellent.


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COMMENTS (15 to date)
Ben writes:

Little tidbit: the top rate in my country (the UK) is not actually 45% either, it is 47% due to 2% 'national insurance' which tries to act like a contributory scheme like Social Security but is actually just an income tax that applies more to lower earners (You pay 12% normally, but it tapers out after earning a certain amount).

Anyway, my country I think can demonstrate why raising income taxes on the rich isn't usually a good idea. 8 years ago, we raised the top rate from 40 to 50% on incomes above £150k (a tiny amount compared to the top rate in the US) - which many thought was a shameless attempt by our centre-left party to put in place politically un-repealable policies in their last year in office (they increased paid holiday leave by a week, they mandated child poverty goals that the government must achieve and they raised the top rate).

This raised less than half than was expected - a petty amount around £3bn - and probably helped worsen our economic performance in the preceding years - we enjoyed a second complete collapse in growth after the recession in 2010-12.

Scott Sumner writes:

Ben, Thanks, that's very interesting. Does the national insurance tax apply to capital income?

Rajat writes:

I'm in Australia and maybe people working in banking/finance are different, but pretty much all the (relatively) highly-paid professionals I know seem to think they should be paying higher marginal rates of income tax. They also think taxes on returns on retirement savings and capital gains should be higher - ie less concessional - than they are. They know nothing about tax theory and don't appreciate that taxing returns to savings primarily hurts savers vis-a-vis spenders, because they presume that anyone who can save is well-off enough to pay more tax.

For most educated upper-class people, supporting a more progressive tax-transfer system is a form of values/virtue-signalling - it means one cares about others and is not materialistic/greedy. These are the values that highly-paid professional people like to exhibit.

Scott Sumner writes:

Rajat, Yes, very few people understand tax theory. I'd say 99% think in terms of how much people pay, relative to income, not incentives to work save, avoid taxes, etc.

Billy Kaubashine writes:

While we're marvelling at how times (and philosophies) have changed, let's not forget that there was a time when "unearned" income (returns to capital) were taxed signifiantly higher than "earned" income (wages, salaries, etc).

The Reagan tax code reversed that with a slight tilt toward favoring capital.

The proposed code takes us back to the imbalance of the early 1970s.....with the positions reversed.

Jon writes:

Scott,

What's confusing to me is how the rest of the world outside of certain socialist hamlets has clearly embraced consumption taxes and low corporate taxes.

The US seems particularly resistant to science on the point of tax policy.

Why is that ?

BC writes:

@Rajat: "For most educated upper-class people, supporting a more progressive tax-transfer system is a form of values/virtue-signalling"

And, it's a much cheaper way to signal virtue than say actually donating money to charity or even the government. When someone says that their own tax rates should be higher, they really mean that *other* people's tax rates should be higher. One can always raise one's own taxes by paying more than required.

Imagine if someone said, "I think I should donate more to charity than I do," without actually subsequently donating more to charity. Would that seem admirable to anyone? Of course not. "Supporting" tax hikes on oneself is a way of not actually having to follow through because the probability that one's own support has a decisive impact on tax law is negligible.

Nicholas Brock Weininger writes:

The best explanation of the tax plan's strategy I have found is that it is designed to maximize the tax burden on the Democratic Party's donor class. Big Dem donors live in rich blue coastal states with high state income taxes: let's kill the deduction for those taxes. They educate their successors at elite universities: let's tax those university endowments. They're generally affluent-to-rich but not superrich professionals: let's raise the MTR on those people's income. They own nice houses where they hold fundraisers for D candidates, in regions where nice houses are really expensive: let's cut their mortgage interest deduction.

So the point is not just to disproportionately burden people who can't be persuaded to vote R anymore anyway, but to take money out of the system that funnels money to D political candidates.

Excellent points! I have watched Republicans out-socialist the Democrats for 40 years!

TaxRefugee writes:

Hi Scott,

The top tax rate would be even higher than you describe in my situation. I'm a minority shareholder in a small business. I sit on the board and am payed $40k for that work, which is in line with IRS guidelines. That means I don't currently max out FICA taxes. I also earn from the business passthrough at a level that would put me in the 49.4% rate. In addition I live in California and had planned on starting a new business next year. So on marginal revenue at my new business I will need to pay the first ~$80k to myself as ordinary wages, which will face a 43.4% + 12.8% for social security + 13.3% for CA taxes = 69.3%. My math may be wrong, and I'm not fully sure if the new bill removes the exemption for the employer portion for FICA, but this is a truly onerous level.

At a ~70% tax rate, I really don't know if I'll bother starting that business. But I'm an optimist: At least I'll be spending more time with my loved ones!

Matthew Waters writes:

TaxRefugee,

I'm confused by your calculation of the marginal rate. I'm a 1099 earner myself, but not above the FICA cap.

As I understand it, if you're in the 39.6% bracket, then your marginal income is above the first FICA tax. The SE portion includes what was paid for W-2 income. If you're earning above the first FICA cap, then the marginal $40k does not pay the 12%.

The Medicare/Obamacare surcharge has no employer portion. So the Federal marginal rate is simply 43.4%. The 13.3% portion to CA depends on whether SALT is deductible. If it's not deductible, then it is 56.7%.

If it is deductible, then tax rate equals 13.3% + 43.4%*(1-13.3%)=50.9%.

The tax bill getting rid of SALT but not lowering top rates is especially punitive for high earners in higher taxed states.

Alec Fahrin writes:

I completely agree with Nicholas Brock. All the reforms in this bill are only there because they harm non-GOP voters.
That means this will be a strictly partisan bill voted on partisan lines. This feels like the Bush tax cuts all over again.
In general (based on analysis from prior tax reform), for every dollar of "reform" you need about three dollars of deficit. That is the bribe you have to pay to blue-state GOP for the removal of deductions like SALT.
So the question here comes down to a basic question: How much can Congress raise the deficit to pay for reforms without alerting deficit hawks?

Will Jeff Flake and Corker stick to their prior promises now that they've announced retirement? What happened to the GOP of 2009-2016?
If the deficit hawks stand firm, some reforms will be sacrificed, and this bill will not pass.
If they betray their constituents, then some reforms can remain, and this bill will be passed.

There is no such thing as a free lunch. Every deficit increase will be paid for, be it directly through tax hikes or indirectly through hidden taxes.
I and my peers will have to pay for these consequences for decades to come.

pyroseed13 writes:

I am not following your argument here. The purpose of the so-called "stealth rate" is to cancel out the benefit that upper income tax payers receive from cuts to the lower brackets. What does this have to do with understanding the difference between marginal and average rates?

Scott Sumner writes:

pyroseed, I agree that that is the purpose (although it's a purpose that makes no sense at all.) But saying that's the purpose has no bearing on how it affects the top MTR. The top MTR is higher than 39.6%, regardless of what Forbes suggests.

What they meant to say is that the highest ATR stayed at 39.6% (or 43.4%)

Quite Likely writes:

This really lays bare Republicans as the party of capital. Their plan is to lower taxes on capital and the people who own capital (corporate taxes, estate tax, etc.) and pay for it in part by raising taxes on people who work. They're not the party of low taxes, they're the party representing a particular interest group.

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