A grinning Alexandria Ocasio Cortez (AOC) garnered considerable media attention with a proposal to raise the top income-tax rate to 70%. Celebrity economist Paul Krugman added to the excitement by endorsing her suggestion as “reasonable.” Both justified the substantial tax hike by reminding everyone who would listen that the country once prospered with maximum rates of that level and higher. As is often the case with easy historical parallels, the justification is misplaced. Much, including the tax code, has changed since then. One can forgive AOC for missing the differences. She, after all, has consistently shown economic and historical ignorance. Krugman, however, should know better.
Krugman used three arguments to argue for such high tax rates: 1) The additional dollars lost to taxes by the rich would hurt them less than if those dollars came from the less affluent. 2) Economic scholarship shows that a high marginal rate on the rich is “optimal.” 3) The United States economy functioned quite well from the mid-1960s through the early 1980s under a 70 percent maximum tax rate and did so under an even higher 92% rate in the 1950s and early 1960s.
His point about relative levels of pain is irrefutable but also beside the point. Of course, the rich can cope better with a higher marginal tax rate. That is why the United States has a progressive system. The more important issue is what such a high rate would do to work incentives and the drive behind business expansion and innovation. On this matter, the best Prof. Krugman can do is either ignore it or deny any effects. Several scholarly studies, however, differ with him or, at the very least, admit that the matter is ambiguous.
On the question of an “optimal” tax rate, Krugman quotes two academic studies. One, by Nobel laureate Peter Diamond and Emmanuel Saez, put the optimal tax rate at 73 percent. The other, by David Romer and his wife Christine, former head of President Obama’s Council of Economic Advisors, put it at 84 percent. What he fails to mention is that neither figure takes account of state and local taxes. When Diamond and Saez make such an accounting, they adjust the optimal federal rate down to 48 percent, still high but closer to the present maximum rate of just under 40 percent than to the AOC-Krugman 70 percent. Though the Romers’ study fails to offer any such adjustment, their statistical work has other problems. It concentrates on the inter-war period when so few fell under the maximum rate as to verge on the statistically insignificant. The authors admit that the matter may introduce biases into their conclusions, as would the number of other shocks befalling the economy at the time. Prof. Krugman fails to mention these points as well.
When he gets to the country’s former prosperity under high tax rates, his analysis gets really fast and loose. It is true that the United States prospered with a 70 percent top rate and higher in the middle of the last century. But when the 70 and 92 percent rates prevailed, the code included a vast array of loopholes that drastically reduced the amount of income actually subject to those high rates. All the tax cuts since have simultaneously closed loopholes.
Between the mid-1960s and the early 1980s, when the 70 percent maximum rate prevailed, taxpayers enjoyed a huge range of tax deductions. They could take from their taxable income all state and local taxes of any kind and with no limit, including sales taxes and licensing fees, property taxes and income taxes. They could also write off all interest expenses without limit on their mortgages, no matter how large or how many. They could also deduct all other forms of interest payment, on credit cards, for instance, as well as on auto loans or home improvement loans, whatever sort of debt they incurred. Picture the benefits to a plutocrat, buying a third home or fifth Mercedes. His or her tax would be calculated on income reduced by all fees and sales taxes and all the interest expenses on the mortgages and auto loans over the years. The code back then included dividend exclusions and generous provisions for capital gains preferences. Taxpayers in those years had no limit on what they could shelter each year in IRAs. All unemployment benefits were tax-free, as were Social Security payouts, no matter how high a person’s income. The code then allowed people to write down their taxable income through averaging provisions and transfer as much income as they liked to their children who paid at a lower rate. There was no limit to the rental loss deduction. Losses for business counted against all income not just the particular venture.
It is not surprising from this wonderful array of breaks that few paid those high rates on much of their income. The non-profit Tax Foundation estimates that in the 1950s, for instance, when the top statutory rate stood at 92 percent, the top 1.0 percent of taxpayers wrote so much income off in the calculation that they paid an effective average rate to the federal government of about 17 percent. If today’s one percent were offered today’s code or the old one, they might well go for the old rules even at a 92 percent top rate. The difference might even explain the graph Krugman shares in one of his pieces in which the top tax rate and the economy’s growth rate seem to go in opposite directions, growth being strongest when the top rate was highest. Perhaps the cause lies in the low effective tax on the wealthy during those years of high statutory rates. Such an explanation is as plausible as any other. Of course, Prof. Krugman does not even mention such matters. Nor does he concede that something else might have affected economic growth rates over the last 70-some years than the top statutory tax rate.
Sadly, Krugman’s argument has gained traction in a media that should show more professional skepticism. But it may not matter anyway. To make such high taxes law, those who support them would have to jump at least four high hurdles. First, they would have to convince the current House leadership to embrace the idea, something for which it has shown little enthusiasm or replace them. Second, the Democrats in the next election would have to keep the House. Third, they would have to capture the Senate. Fourth, would have to capture the White House as well. That is possible, of course, but a tall order indeed.
This piece was originally published on Forbes.com.