Moneybox

Why Taxing the Bejesus Out of the Rich Might Be Useful, Even if It Doesn’t Actually Raise Much Money

Tax cut protester
Reasonable request.
Lindsey Wasson/Reuters

What’s the point of raising taxes on the rich? If you asked most Americans that question, my guess is you’d get a response that might sound something like this:

1. The government needs money.

2. Rich people have all the money (or, at least, much more of it than they realistically need to live happy, healthy, Burberry-clad lives).

3. Ergo, we should tax the rich.

This answer has plenty going for it, including a whiff of common sense. But there’s another important rationale, which is mostly popular these days among thinkers on the political left. The main reason to hike top tax rates, in this view, isn’t to keep the deficit in check; it’s simply to keep individuals from becoming too wealthy, because inequality is itself toxic for society.

That’s the argument economists Emmanuel Saez and Gabriel Zucman laid out Tuesday in a New York Times op-ed. Their hook, of course, is Rep. Alexandria Ocasio-Cortez’s idea to raise the top tax rate to 70 percent on incomes of more than $10 million, which has sparked a monthlong debate about the virtues of soaking the rich. Saez’s own work has featured heavily in that conversation; in 2011, he co-authored a well-regarded paper that suggested the economically optimal top tax rate would be 73 percent, research that has been cited by Paul Krugman, among others. In their Times piece, he and Zucman argue that “root justification” for slapping tax rates on multimillionaires “is not about collecting revenue.” Rather, it’s about combating inequality and “safeguarding democracy against oligarchy.”

This is, suffice to say, a very different way of talking about taxation than what we typically hear in Washington, where the subject is treated as a necessary evil and hiking rates on millionaires is framed in terms of making the affluent pay their “fair share.” Saez and Zucman, like many on the left, don’t think of the issue that way. Instead, they believe the ultra-rich themselves are a policy problem the government needs to address, because an “extreme concentration of wealth means an extreme concentration of economic and political power.” (See: Sheldon Adelson, the Koch brothers, Michael Bloomberg, the Mercers, Tom Steyer, etc.) By this reasoning, high taxes are one solution—a tool for keeping the plutocracy in check. If they also happen to help the federal budget pencil out, that’s just gravy.

What makes their argument especially interesting is how Saez and Zucman believe high taxes reduce inequality. It’s not, as you might expect, because the government uses them to redistribute income. The economists note, for instance, that the 90 percent tax rates of the 1950s only applied to a minuscule slice of Americans whose earnings amounted to about $6.7 million or more in today’s dollars. Conservatives often present this fact as evidence that those rates were a mostly symbolic sham. But Saez and Zucman suggest that the opposite was true. The fact that hardly anybody paid those rates was a sign of their near-total success:

That few people faced the 90 percent top tax rates was not a bug; it was the feature that caused sky-high incomes to largely disappear. The point of high top marginal income tax rates is to constrain the immoderate, and especially unmerited, accumulation of riches. From the 1930s to the 1980s, the United States came as close as any democratic country ever did to imposing a legal maximum income. The inequality of pretax income shrunk dramatically.

In other words, high tax rates discouraged Americans from trying to earn gigantic paydays, because after a certain point the IRS was just going to take 90 cents on the dollar. This, in and of itself, is not exactly an Earth-shattering theory. But if high earners earned less because they cut back on work, or were just less productive, we’d probably conclude those high rates were a net drain on the economy.

Saez and Zucman suggest that wasn’t the case. Unfortunately, in their op-ed, they broadly argue that high taxes have little impact on growth, without getting much into why that might be the case. To understand their thinking more fully, it helps be familiar with research Saez published in 2014 with frequent collaborator Thomas Piketty and Harvard’s Stefanie Stantcheva, in which they hashed out a novel theory about how falling tax rates may have fueled rising inequality.

In tax economics, the standard narrative says that when taxes rise, high earners tend to react in one of two ways: They either work a bit less or find ways to avoid taxes through loopholes. When taxes go down, people work a bit more and spend less time gaming the system. Piketty, Saez, and Stantcheva suggest there was a third variable at play though, which they called “bargaining.” Rather than encouraging high earners to work harder and more creatively, cutting taxes, they suggested, may have led executives and well-paid professionals to spend a lot more time and energy negotiating for luxe pay packages, since the rewards were greater. Low taxes didn’t encourage the rich to grow the pie so much as hog it, and inequality rose as a result.

This was only a hypothesis, but the paper provided some compelling pieces of circumstantial evidence to back it up. Between the 1960s and mid-2000s, countries that cut their tax rates more saw a greater rise in inequality but not greater growth. In the U.S., CEOs often get rewarded with higher pay based on developments they have nothing to do with—the classic examples are oil executives who earn more when the price of crude spikes—and the problem seems to have gotten worse as taxes have fallen. CEOs also seem to earn more in low-tax countries, even when you control for the performance of their companies. These are the sorts of patterns you’d expect to see if dropping top rates mainly spurred executives to focus more on maximizing their compensation.

Even if you assume that there is some trade-off between top taxes and growth, there may still be an upside to limiting the wealth and influence of the very rich (again, think of the Mercers). But if you believe the bargaining theory—and many on the left these days do—then high taxes on the rich start to look less like a trade-off that could drag a bit on the economy, and more like a straightforward tool for regulating greed. And no matter how much, or little, money it raises for the government, regulating greed may be good.