Every so often, a rising young Democratic star comes along with an idea that boldly challenges the status quo. Today, it’s Rep. Alexandria Ocasio-Cortez, who wants to raise the top income tax rate. In 1982, it was Sen. Bill Bradley of New Jersey, who proposed an overhaul of income taxes that “seemed revolutionary and impossible,” The Washington Post said in 1986.
Bradley wanted to seal up loopholes that mainly benefited upper-income people while lightening the load on middle-income individuals and removing many low-income people from the rolls. The result was the historic 1986 tax reform, put together in negotiations with the Reagan administration.
It had the support of most Senate Democrats, including Joe Biden, John Kerry and Ted Kennedy. Oh, and it featured a big change in the top rate — cutting it to 28 percent from 50 percent.
Ocasio-Cortez proposes to move in the opposite direction by boosting the top marginal rate from 37 percent to 70 percent on income above $10 million. It might satisfy the common urge on the left to punish the superrich. But as an economic policy, it is short on virtues.
She and other supporters are fond of noting that in the 1950s and early 1960s, the top rate on individual income topped 90 percent, even as the economy and the living standards of ordinary people improved at a healthy clip. These facts are supposed to prove that high rates are harmless or even beneficial.
What Ocasio-Cortez and others forget is that back then, it wasn’t Republicans who perceived that the punitive rates were damaging. It was President John F. Kennedy, who in 1963 proposed a sharp cut.
“Our obsolete tax system exerts too heavy a drag on private purchasing power, profits and employment,” he said. “It discourages extra effort and risk. It distorts the use of resources.” His effort bore fruit in 1964, after his assassination. The points JFK made are as relevant now as they were then.
One consequence of nearly doubling the top rate, says University of Michigan economist Joel Slemrod, is that high-income people would use every method possible to avoid the higher levy. That’s what they did in the 90 percent days, and there are more escape routes now.
“Bitcoin makes it easy to make financial transactions opaque,” he told me. “The ability to move money offshore is much greater than it was 40 years ago.”
Capital gains are currently taxed at a lower rate than ordinary income — a maximum of 20 percent for assets held for a year or more. If the 70 percent rate were not extended to capital gains, clever rich people and their accountants would look for ways to take their income in the form of capital gains, reducing their tax liability. If the high rate did apply to capital gains, they’d simply avoid capital gains by not selling assets.
“Historically, only a minority of millionaire taxpayers earn over $1 million in consecutive years, and their millionaire status is mainly driven by their choice to realize capital gains,” says Daniel Heil, an economist at the Hoover Institution at Stanford. “So a 70 percent tax rate on capital gains would simply lead to deferring realizations until taxpayers are well below the new bracket.” Or they could avoid the taxes forever by passing this property on to their children when they die.
It’s true that high rates probably wouldn’t deter the typical business mogul from working and investing just as much as before. But in the long run, they would discourage activities that benefit the economy, workers and consumers. Over time, that effect can foster stagnation.
As Hoover Institution economist John Cochrane writes, “High tax countries do not immediately see people staying home from work. But they do not see vibrant business formation and human capital investment.” If Steve Jobs had been deterred from building Apple into the tech giant it became, he would have made far less money, but the rest of us would have lost far more from innovations that would not have occurred.
The point of our tax system should be to raise the amount of money needed to provide for the tasks we expect the federal government to perform — in the way that is likeliest to enhance growth, progress and happiness.
Onerous rates would undermine those goals in a myopic indulgence of populist impulses. Democrats used to understand that.