Will Raising Taxes on the Wealthiest People Hurt the Economy? Probably Not

Warren Buffet has argued that the tax rates on the highest income earners should be increased because he pays a lower tax rate than his secretary. I agree that these tax rates should be increased, but not for the reasons that Mr. Buffet cites, which have mostly to do with the preferential tax rate on capital gains and dividends. Rather, I think that the taxes should be raised because these tax payers, myself included, have benefitted unfairly from the Bush tax cuts that were scheduled to expire at the end of 2010, and because increasing revenue is critical to achieving a balanced budget.

Republicans have staunchly refused to raise taxes, arguing that it will threaten our vulnerable economy. They believe that the highest income earners already pay a disproportionate share of our taxes – the top 5% of tax payers pay 59% of our federal income taxes – and to call on them to take on an even larger burden is unfair. Finally, since they want to shrink the size and scope of the government, they think that raising more revenues would be counterproductive. They would rather keep the pressure on spending reductions.

These latter two concerns are mostly a question of values and I don’t expect much, if any, reconciliation on this issue. But, the argument about economic growth is one that can and should be addressed.

The Republican position argues that a tax increase will diminish economic activity and a tax decrease will stimulate the economy, a claim first popularized by the economist Arthur Laffer. While I agree with this proposition in general, there is little to no evidence that it is true with respect to the tax rate on the highest income earners. For the not-mathematically-faint-of-heart, Peter Diamond and Emmanuel Saez argue persuasively that “Very high earnings should be subject to rising marginal tax rates and higher rates than current U.S. policy for top earners.” They suggest that a tax increase on the highest earners would not reduce economic activity.

I find the following chart of maximum tax rates and economic growth helpful in understanding how tax rates affect economic growth.

Source: Citizens for Justice

There was no noticeable effect on GDP when the top rate fell in the 1960s and 1980s, nor in the early 1990s when the top rate increased. Rather, I think that it is pretty clear from this chart that tax rates in this range have not had any effect on economic growth.

What about the assertion that a tax increase on high earners is going to disproportionately affect small business owners, who are the engines of job creation? The reality is that only 3% of business owners, regardless of the size of their companies, report earnings over $250,000. Furthermore, the average tax rate that they pay is only 20%. Are we really to believe that small businesses are going to close up the shop to avoid a couple more percent in taxes? The facts simply don’t support the assertion.

This country faces a serious budget crisis over the next decade. While progress must come from the spending side, most importantly in Medicare and Medicaid, it is delusional to think that we can prevent our debt from growing to dangerous levels without increasing revenues. It is time for the members of Congress to break ranks with their extreme factions and do the right thing for the country.

Frank Trainer, the former director of fixed income at Sanford C. Bernstein & Co., Inc., is a member of the Board of Directors of The Hastings Center.

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3 Comments

  1. OK, fair enough.

    Is there any evidence that it would help much? I’m not specifically against the idea of raising taxes on the top 1%, but how much cash could it conceivably raise? That seems an important fact to include in the debate. The only analysis I’ve seen of this question pertains to Canada, not the US, and the conclusion was that any plausible tax hike would raise so little extra cash that it’s basically a waste of time, at least if the point is to try to fix things financially.

  2. frank trainer says:

    The taxpayers earning over $500,000 paid $262 billion in 2009, while those earning over $200,000 paid $429 billion. http://​www​.irs​.gov/​t​a​x​s​t​a​t​s​/​i​n​d​t​a​x​s​t​a​t​s​/​a​r​t​i​c​l​e/0„id=133521,00.html It’s pretty easy to see that a couple of percent increase in the marginal tax rate will raise over $1 trillion per year. The projected deficit for 2012 is projected to be $7 trillion, and declining to $3 trillion by 2014 http://​www​.cbo​.gov/​f​t​p​d​o​c​s​/​1​2​0​x​x​/​d​o​c​1​2​0​3​9​/​0​1​-​2​6​_​F​Y​2​0​1​1​O​u​t​l​o​o​k​.​pdf, so the revenue implications of raising the tax rate on the highest earners is significant.

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