A 90 percent tax rate on the top 1 percent of American earners wouldn’t just significantly reduce income and wealth inequality and boost government tax revenues. It would also be the optimal level for Americans’ welfare, according to a new paper from economists Fabian Kindermann and Dirk Krueger.
They find that the top marginal tax rate that maximizes government revenues before being so high as to discourage the wealthiest from earning more is very high, or 95 percent on those who are among the top 1 percent of earners. They also find that a 90 percent tax rate on the richest 1 percent could significantly reduce the Gini index, a measure of income inequality, and wealth inequality would also steadily decline.
But these effects aren’t worth the policy change in and of themselves, they argue. In an email to ThinkProgress, Krueger wrote, “One could certainly reduce inequality in the economy to zero, by the government confiscating all income and wealth and redistributing it equally among all households… Of course people would stop working and saving and the outcome would be disastrous.” But the interesting finding in their paper is that the same tax rate that would maximize revenues and drive down inequality is nearly the same one that would make everyone better off, or what they call the optimal top marginal tax rate.
Everyone’s welfare is improved if a tax change allows the government to compensate them with enough wealth so that they are at the same level they were before the change, but the government still has money left over. “The more is left over, the better is the reform,” Krueger said. Everyone’s welfare improves or stays steady, including that of the 1 percent, under a 90 percent top tax rate. In fact, the welfare gains are “very substantial,” they note in the paper.
There are trade offs to such a policy change. About 10 percent fewer people would enter the labor force and consumption would decline in the long run by about 7 percent. But most of this would happen at the very top and not impact most Americans. Average consumption for people who don’t make it to the top 1 percent would actually be higher. Most of the labor force reduction is also among the richest. “Not knowing whether one would ever make it into the top 1% (not impossible, but very unlikely) households would be eager to accept a life that is somewhat better most of the time…and significantly worse in the rare case they climb to the top 1%,” Krueger noted.
The top 1 percent paid an average tax rate of 23.5 percent in 2011, below a peak of 27.6 in 2001. The rate had been dropping for many years, although what they’re paying now represents a slight increase. Either way, though, the rate is much lower than 90 percent.
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While conservatives warn that higher tax rates on the wealthy will hurt so-called “job creators,” economists point out that higher taxes and economic growth can go hand-in-hand. After World War II, higher economic growth occurred alongside higher top tax rates, averaging 2.23 percent while the top rates were above 70 percent between 1950 and 1980 but just 1.68 percent when the rates were lower between 1980 and 2010. Job growth has been weakest when the top rate was lowest and stronger when it was higher.
Without any policy change, however, income and wealth inequality are set to keep growing. Income inequality has been growing steadily since the 1970s and the recession has made it even worse, while wealth inequality is now where it was in the 1920s and continues climbing.