Emmanuel Saez gave a presentation on income
inequality at the Western Economic Association
International conference in Portland a couple
weeks ago. One of his trend diagrams shows
the fall in marginal tax rates
beginning with John Kennedy in the early 1960s
and continuing with Ronald Reagan in the 1980s.
The share of national income going to the top
one percent increased after the top tax rate
was lowered. He suggested three possible
explanations for this effect.
- One possibility is the supply side explanation,
that tax rates affect incentives.
High tax rates deter productive effort and therefore
there would not be as much income generated. - Another possibility is tax avoidance as high
income taxpayers put more effort into finding
ways to avoid paying taxes by finding loopholes. - A third possibility is called rent-seeking.
Perhaps high income taxpayers
have twisted the process of compensation-setting
in their favor, and they are more likely to do
this when tax rates are lower.
With a very high tax rate on high incomes
then the high income earners may think “what’s
the point?” and give up on trying to twist
the compensation process in their favor.
As usual economics is complicated and
most likely all three of the effects
are important. All three of these should
really be considered as part of supply side
economics, which claims that tax rates affect
incentives and incentives affect behavior.
In particular it is important to look at the
total revenue collected from the tax.
If tax rates are lowered without
a significant loss of revenue then it means
that it’s possible to bring in needed government
revenue with less perverse effects on incentives,
either rent seeking behavior or otherwise.
Rent-seeking is an odd economic term that
does not have to do with landlords receiving
payment from tenants but instead refers to
people trying to use influence to twist
the political system in a way that creates
some kind of legal privilege that can be used
to generate income as if it were an asset
Tax avoidance behavior is an activity that
means talented people are doing something that
is not very productive.
Saez underestimates the significance of
tax avoidance, particularly before the bipartisan 1986
Tax Reform act. In any case reforming the tax
code to further reduce loopholes and make
it clearer would provide benefits.
A clearer tax code could still be progressive.
The degree of progressivity you think that the
tax code should have is a matter of opinion
with no right answer.
To the extent that the problem is rent-seeking
(high income people being able to twist compensation
setting in their favor) the solution should be to fix
those problems. Saez’s suggestion that a high marginal
tax rate would reduce that behavior raises the problem
that the high tax rate would cause a lot of collateral
damage by deterring productive activity.
Missing from Saez’s presentation was any mention of
the corporate income tax. Since the incidence of the
corporate income tax is not clear that makes it very
difficult to design a tax system to meet distributional
goals.
Saez is working with Thomas Piketty on a study of
distributional national accounts (see
http://piketty.pse.ens.fr/files/PikettySaezZucman2015DINA.pdf
There is more about taxation and inequality in
Freedom, Opportunity, and Security.
……………..
–Douglas Downing
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