Let Them Eat Cake, But Raise Their Taxes

Newly-elected Alexandra Ocasio-Cortez (aka AOC) is the youngest person in Congress. She is becoming very well-known. Last week, she was asked about funding the Green New Deal, the plan to eliminate U.S. carbon emissions and move away from fossil fuels within ten years. This is what she said:

Once you get to the tippie-tops, on your $10 millionth dollar, sometimes you see tax rates as high as 60% or 70%. That doesn’t mean all $10 million dollars are taxed at an extremely high rate. But it means that as you climb up this ladder, you should be contributing more.

Right-wingers immediately screamed that a tax rate that high would be the equivalent of slavery. They didn’t bother to point out that she was referring to the “marginal” tax rate, the percentage at which income over a certain threshold is taxed. That’s very different from taking 60% or 70% of someone’s entire income.

The economist Paul Krugman explains why the 60% or 70% marginal rate is an excellent idea:

The right’s denunciation of AOC’s “insane” policy ideas serves as a very good reminder of who is actually insane.

The controversy of the moment involves AOC’s advocacy of a tax rate of 70-80 percent on very high incomes, which is obviously crazy, right? I mean, who thinks that makes sense? Only ignorant people like … um, Peter Diamond, Nobel laureate in economics and arguably the world’s leading expert on public finance…. And it’s a policy nobody has ever implemented, aside from … the United States, for 35 years after World War II — including the most successful period of economic growth in our history.

To be more specific, Diamond, in work with Emmanuel Saez — one of our leading experts on inequality — estimated the optimal top tax rateto be 73 percent. Some put it higher: Christina Romer, top macroeconomist and former head of President Obama’s Council of Economic Advisers, estimates it at more than 80 percent.[

Where do these numbers come from? Underlying the Diamond-Saez analysis are two propositions: Diminishing marginal utility and competitive markets.

Diminishing marginal utility [i.e. the value of something at the margin] is the common-sense notion that an extra dollar is worth a lot less in satisfaction to people with very high incomes than to those with low incomes. Give a family with an annual income of $20,000 an extra $1,000 and it will make a big difference to their lives. Give a guy who makes $1 million an extra thousand and he’ll barely notice it.

What this implies for economic policy is that we shouldn’t care what a policy does to the incomes of the very rich. A policy that makes the rich a bit poorer will affect only a handful of people, and will barely affect their life satisfaction, since they will still be able to buy whatever they want.

So why not tax them at 100 percent? The answer is that this would eliminate any incentive to do whatever it is they do to earn that much money, which would hurt the economy. In other words, tax policy toward the rich should have nothing to do with the interests of the rich, per se, but should only be concerned with how incentive effects change the behavior of the rich, and how this affects the rest of the population.

But here’s where competitive markets come in. In a perfectly competitive economy, with no monopoly power or other distortions — which is the kind of economy conservatives want us to believe we have — everyone gets paid his or her marginal product. That is, if you get paid $1000 an hour, it’s because each extra hour you work adds $1000 worth to the economy’s output.

In that case, however, why do we care how hard the rich work? If a rich man works an extra hour, adding $1000 to the economy, but gets paid $1000 for his efforts, the combined income of everyone else doesn’t change, does it? Ah, but it does — because he pays taxes on that extra $1000. So the social benefit from getting high-income individuals to work a bit harder is the tax revenue generated by that extra effort — and conversely the cost of their working less is the reduction in the taxes they pay.

Or to put it a bit more succinctly, when taxing the rich, all we should care about is how much revenue we raise. The optimal tax rate on people with very high incomes is the rate that raises the maximum possible revenue.

And that’s something we can estimate, given evidence on how responsive the pre-tax income of the wealthy actually is to tax rates. As I said, Diamond and Saez put the optimal rate at 73 percent, Romer at over 80 percent — which is consistent with what AOC said.

An aside: What if we take into account the reality that markets aren’t perfectly competitive, that there’s a lot of monopoly power out there? The answer is that this almost surely makes the case for even higher tax rates, since high-income people presumably get a lot of those monopoly rents.

So AOC, far from showing her craziness, is fully in line with serious economic research. (I hear that she’s been talking to some very good economists.) Her critics, on the other hand, do indeed have crazy policy ideas — and tax policy is at the heart of the crazy.

You see, Republicans almost universally advocate low taxes on the wealthy, based on the claim that tax cuts at the top will have huge beneficial effects on the economy. This claim rests on research by … well, nobody. There isn’t any body of serious work supporting G.O.P. tax ideas, because the evidence is overwhelmingly against those ideas.

Increasing marginal rates as income rises is called “progressive” taxation. It’s fair and practical. Republicans are against it, preferring a “flat” tax, where all income is taxed at the same rate. A flat tax let’s the rich keep more of their income. They say it’s fair and simple, but that’s not why they’re for it.

End Poverty and Bring Back the 90% Income Tax!

If you’re feeling too optimistic about the future and want a bracing jolt of economic reality, you might want to read Paul Krugman’s latest column. It’s called “A Permanent Slump?

Professor Krugman considers the possibility that the normal state of our economy is now mild depression (what psychiatrists call “chronic dysthymia” in another context). He describes it as “a persistent state in which a depressed economy is the norm, with episodes of full employment few and far between”.

Krugman points out that the economy hasn’t done especially well for most people in recent decades, even when we were in the midst of a housing bubble and consumers were taking on increasing amounts of debt. By now, the economy should have recovered nicely from the financial crisis of 2007-2009, but it hasn’t. As he puts it:

The evidence suggests that we have become an economy whose normal state is one of mild depression, whose brief episodes of prosperity occur only thanks to bubbles and unsustainable borrowing.

I went out to rake leaves after reading this. It was a beautiful fall day, very conducive to deep thoughts about politics and the economy. After ruling out the violent overthrow of the government, I concluded that there are a couple of things we need to do.

1) Establish a guaranteed minimum income, like Switzerland is considering. If too many people can’t find a decent job in this country, let’s at least make sure the worst off have a reasonable amount of money to live on. Maybe we don’t need as many people working as we used to, back before the “Information Revolution” and the “Global Economy”. Danny Vinik of the Business Insider makes a strong case here. He argues, for example, that most people would still want to work. I think one important result would be that the economy as a whole would benefit if people with low incomes had more money to spread around.

2) Bring back the progressive income tax, like we used to have when this country worked well for the majority of people. As recently as 1963, the highest tax rate was 90%. Of course, that doesn’t mean that someone making a million dollars a year (who made that kind of money back then?) had to pay $900,000 in federal taxes. The 90% rate applied to income above a certain threshold. As recently as 1980, the highest rate was 70%. Now, after the “Reagan Revolution”, it’s 35%. We’re still waiting for the wealth to trickle down. It might be the case that lots of billionaires and multi-millionaires would move to the Bahamas. (Good riddance.) But it would allow us to move away from being a “Winner Take All Society“.