High Tax Rates Aren’t Optimal

Nobody really thinks a top rate of 70% or 80% is a good idea in the real world.

By Holman W. Jenkins, Jr. Excerpts:

"A 2011 paper by Peter Diamond and Emmanuel Saez, based on a variety of extrapolations, calculates that the “optimal” top tax rate is 73%. A paper the same year by Christina and David Romer finds an even higher “revenue maximizing” top tax rate of 84%.

Case closed? Not even slightly. Messrs. Saez and Diamond are describing a world in which the wealthy have no opportunity to shield or hide their incomes. Look closely and the authors’ “optimal” top federal rate quickly becomes 48% in a tax code like America’s when state taxes are included.

And not even the Romers are convinced by their 84% top rate. Their study looks only at interwar tax returns, when the tiny number of relevant taxpayers received mostly partnership and dividend income. Their work tells us nothing about an 84% rate’s impact on labor effort in an economy like today’s.

They also point out that some of their data are “imperfect” and the results “perverse.” To wit, did the rich in the 1920s and ’30s really spend more on machinery and equipment even as the tax hit went up, yet at the same time form fewer new businesses?

Their findings, they add, may be “confounded by the enormous shocks affecting the economy over this period” (war, inflation, deflation, depression). And their results fly in the face of “comparable postwar studies” that find significant detrimental effects from high marginal tax rates. On second thought, their own study may find such effects too if their discovery of reduced business incorporations in the 1920s and ’30s “holds up under further scrutiny.”"

"A large and growing literature continues to support the claim that high marginal tax rates and big tax hikes are harmful to economic well-being. See the work of the Dallas Fed’s Karel Mertens and colleagues, or the Romers’ own 2010 work finding a “highly contractionary” effect from postwar tax hikes."