April 20, 2014

Upper-Income Tax Rates Would Need Dramatic Increases If President Wants to Keep His Tax Cut and Deficit Reduction Promises

  • The federal budget is an expression of our country's values. Where we choose to spend and at what levels, how and who we tax, and the borrowing we...

Recently on The Concord Coalition Blog, The Tabulation, Chief Economist Diane Lim Rogers examined how difficult it will for President Obama to both keep his pledge to reduce the deficit to around 3 percent of GDP annually and to not raise taxes on households earning less than $250,000 a year.

Using a recent analysis by the Tax Policy Center, Rogers suggests that the top two income tax rates would have to go from 33 percent to 72 percent, and from 35 percent to 77 percent. While this represents a highly progressive tax strategy, it would not necessarily be a "good" deal for even the vast majority of households not in the top income brackets.

Having a pattern of marginal tax rates that rises so steeply at the top would create huge disincentive effects on labor supply and saving. If marginal tax rates are raised to prohibitive levels, then the labor supply and saving of the rich are reduced, overall economic growth is reduced, and employment and wages -- economy-wide and throughout the income distribution -- suffer. Furthermore, even without this "supply side" argument, it's just not good or sustainable tax policy to rely on such a huge increase in taxes on such a small percentage of the population to fund a cause (deficit reduction) that would otherwise have large and broadly-distributed benefits.

Rogers concludes the easiest way to achieve the 3 percent deficit goal is to stick with current law, with all of the Bush tax cuts expiring as scheduled at the end of this year. Of course, a better way would be to stick to current-law revenue levels by reforming the tax system -- broadening the tax base to make it more efficient so that marginal tax rates would not even have to come up and we could still raise more revenue to achieve our deficit goal.