A reader in Kansas City writes:
If income tax rate increases plus surcharges combine to push the effective rate for “the rich” up past 40 percent, won’t we likely see a dramatic DROP in the income of the top one percent? Presumably many of the business owners who now treat their corporate earnings as personal income through LLCs and S-Corps will choose to return to their pre-1983 pattern of paying corporate tax instead (at 35 percent).
Possible impacts: Voila, the rising income gap plummets. Personal tax receipts for health care reform fall short. Corporate tax receipts rise sharply—but presumably with significant pressure on corporations to adopt new strategies for tax avoidance.
I imagine all these things would happen to some extent; I don’t think anybody has a good sense of how dramatic the impact would be. But with the 5.4% surtax proposed for those with an adjusted gross income above $1 million, and lots of fiscally troubled states raising taxes at the top end of the income scale, the Tax Foundation has estimated that 39 states would have top marginal tax rates above 50%. Oregon would be the champ, with a top marginal income tax rate of 57.54%. When tax rates get that high, the incentives to go through contortions to avoid them get pretty high, too. Moving business income from the personal tax form to a corporate one is a pretty simple step many high-income individuals can and will take to avoid the new top rates.
None of that means the surtax isn’t worth doing. Just that there will be diminishing returns to raising tax rates.