Is the U.S. Due for Radically Raising Taxes for the Rich?

Posted: 8th August 2016 by Khannea Suntzu in Uncategorized
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That’s what has usually happened whenever a large proportion of Americans have been upset with the distribution of their country’s wealth.

In one of the biggest moments of Hillary Clinton’s convention speech, the Democratic nominee promised that under her presidency, “Wall Street, corporations, and the super-rich are going to start paying their fair share of taxes.” The crowd went wild.

This idea, that the wealthiest Americans have been helped along financially by their ability to shortchange the tax system, is a popular view at a time when the divide between the richest and everyone else continues to grow. According to a Gallup poll, 63 percent of Americans say the distribution of money and wealth is unfair, and just over half favor higher taxes on the rich.

It’s clear that many people believe that it’s time to lessen inequality. But what’s the best way to proceed?

“I think it is high time for the U.S. to push up the top tax rate,” Emmanuel Saez, a Berkeley professor who is one of the country’s top experts on wealth accumulation, told me. After all, the top tax rate right now, 39.6 percent, is much lower than the 70 percent rate that existed through much of the period between the 1930s and 1970s, when wealth was more evenly distributed in the United States. This might suggest that if economic equality is truly the goal, perhaps tweaking the tax rate might help.

The trouble is, taxation remains one of the most contested issues in modern political conversation. There are plenty of people who would argue that raising taxes may do more harm than good to the economy. If the rich are taxed more, they may become even more motivated to move their money offshore or to accounts where it can’t be tracked. That could mean less revenue for the government and government services in the end. And if the wealthy aren’t making, or keeping as much money—some say—the result could be a reduction in economic activity, with less capital available for entrepreneurship, leading to lower rates of business formation and fewer jobs. If true, that would be bad for the entire economy, especially low-wage earners.

But there is historical evidence that suggests these fears may not be more conjecture than actual threat. The U.S. economy is becoming less entrepreneurial over time, suggesting that the wealthy aren’t creating new businesses with all that extra money that used to go to taxes. And in the past, raising top tax rates hasn’t actually depressed economic activity or caused people to stash more money offshore. History also suggests that increasing top tax rates reduces inequality.

Compare, for example, taxation in the United States and Denmark in the periods 1975 to 1979 and 2004 to 2008, as Thomas Piketty, Emmanuel Saez, and Stefanie Stantcheva did in a 2011 paper. In the United States of the 1970s, the top bracket was taxed at a rate of 70 percent, compared to 39.6 percent today. During the latter half of the 1970s, the top 1 percent of earners accounted for around 8 percent of Americans’ total income. Denmark taxed its top earnings similarly, at around 65 percent, and the top 1 percent of earners accounted for about 4 percent of total income. Fast-forward to the 2004 to 2008 period, when the tax rate of top earners in the U.S fell to 35 percent. The share of income accrued by the top 1 percent reached 18 percent. Denmark, which went through a similar period of economic activity and development, according to researchers, kept the tax rate of its highest earners at a comparatively high rate of nearly 60 percent. The result was that the top 1 percent of earners in Denmark still took in around 4 percent of total income by the year 2008.

Denmark isn’t the only evidence of this phenomenon. Among OECD members, as tax rates on upper-income earners fell—mostly in English speaking countries like the U.S. or Britain—the share of income accruing to the top 1 percent grew. Keeping tax rates high didn’t harm a country’s GDP either, the authors found, suggesting that high taxes didn’t lead productive earners to flee, and low tax rates didn’t motivate them to produce more. According to the paper, while there isn’t a lot of proof that high taxes result in economic slack, there’s a compelling link between low taxation and a growth in inequality. “No country experiences a significant increase in top income shares without implementing significant top rate tax cuts,” the authors write.

Besides the obvious fact that tax cuts put more money into high earners’ pockets, there are a number of reasons that lower tax rates result in more income becoming concentrated at the top, Saez told me. High tax rates make it harder for top executives to make the case for astronomical salaries; if a huge share of their pay is just going to go to taxes, corporate boards will be less likely to pay out high sums that are ultimately funneled back to the government. And when taxes are high, the wealthy can’t put as much into savings since so much of their income goes to the government.

Things haven’t always been the way they are now. Wealth concentration was high in the beginning of the 20th century, but then dropped from 1929 to around 1978, according to a recent paper by Emmanuel Saez and Gabriel Zucman of Berkeley. It’s risen steadily since then.

Still, despite evidence that raising the top rates would lower inequality, it would be politically difficult to do so, especially in the current climate. But it’s been done before, says Marshall Steinbaum, a visiting fellow at the Roosevelt Institute who has studied the history of taxing the rich. In the 19th century, the United States was governed by the same type of free-market paradigm that rules the country today: Leave it to the market to sort everything out. But over the late 19th century and early 20th, the progressive movement gained steam, and there emerged a political argument that the laissez-faire attitude of the government was allowing too much inequality to grow. Enter the economist Edwin Seligman, a scion of a New York banking family, who published a paper in 1910 advocating for the introduction of an income tax in order to finance government functions. The Sixteenth Amendment, which allowed for an income tax to be levied, passed in 1913. Over time, an idea that had been advocated by mostly left-wing economists became mainstream, Steinbaum told me.

Raising the top brackets back to what they were in the periods of less inequality may still be seen as left-wing today. But that could evolve. There is precedence for the top rates being raised significantly, especially at times when public opinions about wealth were very similar to Americans’ today. I talked to David Zalewski, a professor of finance at Providence College who has studied the Revenue Act of 1932, under which the marginal tax rate jumped from 25 percent to 63 percent for top earners. Of course, 1932 was a very different time economically: Most importantly, the United States was on the gold standard and its economy was running a big budget deficit, so those in business were concerned that the country would start printing money to close the gap. This would devalue the dollar significantly, harming their ability to trade and buy and sell in dollars.

So President Hoover floated the idea of significantly raising taxes on the rich to close the budget hole instead. The wealthy didn’t hate the idea, Zalewski said. Paying higher taxes was better for them than having the dollar devalued so significantly that they couldn’t trade it for anything. “An unbalanced budget was the worst thing you could do in national policy during the gold standard era,” Zalewski told me. The Revenue Act of 1932 more than doubled tax rates on the rich—the largest peacetime tax increase in American history. And aside from big increases on the rich, the act included consumption taxes on gasoline and electricity, according to the Tax History Project, a collection of essays about financial history from the non-partisan nonprofit Tax Analysts.

The following year, Franklin Delano Roosevelt took office. He took the country off the gold standard, but saw no reason to lower tax rates since he had a laundry list of social programs he wanted to fund. Instead, he passed the Revenue Act of 1935, which actually raised the top tax rate even higher, to 79 percent. Critics derided this as a “soak the rich” tax. But the country seemed to content to keep the trend going. Between 1935 and 1982, the top tax rate did not dip below 70 percent. Part of this was due to a belief among those in charge that the government had a role in combating extreme wealth. Roosevelt said this in a speech about raising taxes:

People know that vast personal incomes come not only through the effort or ability or luck of those who receive them, but also because of the opportunities for advantage which Government itself contributes. Therefore, the duty rests upon the Government to restrict such incomes by very high taxes.

And that wasn’t an extreme view. For a long time, says Saez, the idea that earning a ton of money was, in some ways vulgar or unfair dictated policy. During World War II, the government even controlled pay increases in the private sector. Even when those controls were lifted, income inequality stayed constant at low inequality. This is a period of income equality referred to by economists as the Great Compression.

It wasn’t until the Reagan era that the politicians in power started to talk up the benefits of wealth accumulation once again. Top tax rates fell, from 70 percent to 50 percent, in 1982, and then to 38.5 percent in 1987. At the same time, the top 0.1 percent of earners’ share of wealth has risen from 7 percent in 1978 to 22 percent in 2012, a level almost as high as in 1929, according to a May paper by Saez and Zucman that tracks wealth inequality in the United States since 1913.

The gap between the wealthiest and everyone else has grown so large that economic experts around the world have listed the issue of one of the main concerns facing the global economy. To reverse the extreme concentration of wealth that has characterized the last few decades, Saez says, changes to the top tax rates would have to be relatively large—bigger than the changes in the Clinton era, which saw the top tax rate grow from 31 percent to 39.6 percent, or those in the Obama era, which saw the top tax rate grow from 35 percent to 39.6 percent. And increases in the top tax rate would have to be accompanied by concrete changes in the tax system so that it’s not as easy for the rich to avoid paying taxes. Saez’s colleague Zucman estimates that 8 percent of the world’s financial wealth is held offshore, costing the US alone $36 billion a year.

Fixing a problem of that magnitude seems like a stretch. But it’s possible to prevent as much hiding of offshore wealth, Saez says, if governments want to work together to punish countries that allow capital to be hidden in their banks. The Foreign Account Tax Compliance Act, passed in 2010, is a good start, he said. It required American expats to report assets held in foreign banks, and also required foreign banks to report significant assets held by Americans. A next step, Zucman suggests, could be slapping tariffs on goods imported from tax havens. Adding a 30 percent tariff to Swiss goods, for instance, would end up costing Switzerland more than the country earns for being a tax haven, which could be motivation for the country to comply with stricter reporting requirements.

“This is really a choice—if all the big countries, the U.S., countries in Europe—really wanted it to be done, they could do it,” Saez told me. This is the same for raising top tax rates, it seems. History suggests that doing so could help reduce income inequality and wealth concentration at the very top. But the U.S. must really want it to be done.

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