Legislation

The Unworkable 70 Percent Tax

During the first week of her new job as a representative from New York, Alexandria Ocasio-Cortez proposed a top statutory tax rate of 70 percent. Her stated goal is to raise revenue to fund what she calls the “Green New Deal,” an effort to transition the U.S. economy to fully renewable energy in ten years.” data-reactid=”18″>During the first week of her new job as a representative from New York, Alexandria Ocasio-Cortez proposed a top statutory tax rate of 70 percent. Her stated goal is to raise revenue to fund what she calls the “Green New Deal,” an effort to transition the U.S. economy to fully renewable energy in ten years.

Ocasio-Cortez has yet to release the specifics of her new plan. However, her comments imply that she wants to add an eighth tax bracket of 70 percent on incomes over $10 million. What this means is that if you are a very high earner, such as a successful actor, musician, or business owner, you would need to pay 70 cents for every dollar you report in taxable income over $10 million. It’s not clear yet whether it would apply only to earned income, or if it would apply to all income, including capital gains, dividends, and business income. However, given her stated goal, it is likely the latter.

Unfortunately for the congresswoman, estimates that show a significant increase in revenue from a 70 percent tax rate on incomes over $10 million are unrealistic. This is because individuals — and their accountants — would react to the new 70 percent rate by finding ways to report less income. They would save 70 cents for every dollar not reported above that threshold.

According to the IRS, about 46 percent of all income reported by those earning more than $10 million is made up of capital gains, meaning income from the sale of assets such as stocks. Under current law, capital gains are taxed only when they are “realized” — that is, when the assets are sold, not every time they gain value. This means that individuals can effectively choose when to pay the tax. And individuals who hold on to assets until death can have their gains completely erased through what is called “step-up in basis.”

strong negative relationship between the tax rate on capital gains and realizations. They found that over the long run, a 10 percent increase in the tax rate on capital gains reduces realizations by around 7 percent. This implies that the revenue-maximizing capital gains rate is around 29 percent; a rate approaching 70 percent would likely reduce federal revenue from changes in capital-gains behavior.” data-reactid=”23″>Researchers at the Joint Committee on Taxation found that there is a strong negative relationship between the tax rate on capital gains and realizations. They found that over the long run, a 10 percent increase in the tax rate on capital gains reduces realizations by around 7 percent. This implies that the revenue-maximizing capital gains rate is around 29 percent; a rate approaching 70 percent would likely reduce federal revenue from changes in capital-gains behavior.

Fortunately, knowledge of tax policy has evolved and improved over the past 50 years. Research by economists and tax analysts has convinced lawmakers throughout the world that high marginal tax rates are a poor way to raise revenue. High marginal tax rates discourage individuals from working additional hours and discourage businesses from making productivity-enhancing investments.

As a result, tax reform across the globe has moved tax systems away from high marginal tax rates with narrow bases to lower marginal rates and broad bases. The U.S. is not the only country that greatly reduced marginal tax rates over the past 50 years. According to the Organisation for Economic Cooperation and Development, the simple average top statutory tax rate has declined from 57.1 percent to 35.8 percent among the group’s member nations. At the same time, revenue collections remained stable or rose as these same countries enacted broad-based taxes such as value-added taxes, payroll taxes, and broader individual income taxes.

Overall, lawmakers such as Ocasio-Cortez, who want to see the government raise a much larger share of revenue as a percent of GDP to fund their priorities, need to get more serious about tax policy. Yes, it is possible to raise additional revenue by raising taxes on high earners through eliminating tax expenditures, reforming capital taxation, and raising rates. But there is a limit. Any proposal that raises a significant amount of revenue will have to do so through broad-based taxes on all Americans, not just the highest earners.

If we look across the Atlantic at countries with significant revenue collections as a percent of GDP, taxes are generally high for everyone. Denmark, Sweden, and Finland all raise more than 40 percent of GDP in tax revenue. These countries have broad-based value-added taxes over 20 percent and high payroll taxes. Their income taxes have high marginal tax rates, but they apply to much more personal income than what Ocasio-Cortez is proposing. For example, in 2015, Denmark’s top marginal tax rate of 60 percent started applying at 1.2 times the average income. If that were enacted here, all taxable income over $56,500 would face a 60 percent tax rate.

Broad-based taxes would be a better way to raise significant revenue for the federal government. However, the need to raise revenue from everyone, not just the highest earners, increases the burden of proof on proponents of new government programs. If they are to get voters behind a middle-class tax increase, they need to convince the public that their new policies are worth it. Simply claiming that someone else will pay for it is not enough.

The design of a tax matters for how it affects incentives and how much revenue it raises. A sharply higher top marginal tax rate would ultimately fail to accomplish the congresswoman’s goal.

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