What if Tax Rates Were Set by Lottery?

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One of the big reasons people argue against raising taxes for the richest Americans is that higher taxes make people less inclined to work. The result is that raising taxes at some point doesn’t raise any more tax income for the government. This is in effect the famous Laffer Curve.

I’m not sure I believe that. I think people, particularly rich ones, work for a lot of reasons, and absolute wealth is only one of them. Nonetheless, a study that I found on the National Bureau of Economic Research website, argues just the opposite. A working paper from 2000 co-authored by Berkeley tax expert Emmanuel Saez and Jonathan Gruber, found that for marginally rich people (those making more than $100,000) tax rates do seem to matter. They tended to either work less or hide more of their income when tax rates rose. People making less than $100,00 did not seem to change their behavior much. That suggests that the richer you are the more you care about tax rates, though I wonder if we would see the same change in behavior for people making more or less than $500,000.

But what if it’s not the tax rates that matter when it comes to how much you will work, but rather the knowledge of tax rates. That brings me to an interesting suggestion that a reader jimtobias had in reaction to a recent post I wrote about what would happened if the top tax rate was raised to 99.99%. How about we have a tax rate lottery?

Here’s another idea. Let’s say that all income below $500K was subject to taxation as it currently is, and that income above that level was subject to a tax rate lottery, held after the income is declared. Some of it gets taxed at, say, 75%, and some is not taxed at all. The goal is to increase revenue from this segment by, say, 10%. Quite a few $B. Maybe the “losers” are exempted from next year’s lottery; they’ll be taxed at the current rate.

Both categories of rich folks get a sociocultural benefit. The “winners” get to splurge and tell the tale of escaping from the clutches of the taxman; the “losers” get to carp about carrying their weight of the poor and the undeserving public sector. They already tell stories like this, but now they can do it with more public confirmation. There’s drama, sport, opportunities for character development, and of course, an intensification of media fascination with the doings of the rich.

I wonder if anyone has studied it. My quick search on NBER on “tax rate lottery,” didn’t turn up any papers. With a few caveats, I think this is an interesting idea. Here’s why:

A few months ago I proposed having a floating tax rate that would rise or fall based on the budget needs of each year. The post was based on the fact that property tax revenues had not fallen as property tax rates had generally been going up.

Again, people will say that local property taxes are not a good study of tax policy. City governments game assessments and set tax rates to a level that they know will generate the right amount of income to match spending, or at least come close. OK. But maybe that’s what we should do on a national level. Instead of keeping our income tax rates the same level every year, and trying to change spending around to reflect that. Maybe income tax rates should float based on the government’s spending needs.

The idea of a tax rate lottery may make even more sense than my proposal, because that would allow the government to put money away for future years, like say recessions when incomes fall. My only problem with the idea is that at a time when we have runaway deficits and political gridlock because of the national debt, I think would have to make sure that a scheme like this would definitely boost tax revenue. And I think that could be a tricky thing. Not only do you have to make sure that the rates that people pull out of the magical tax rate lottery hat average to something higher than we have today, you would have to make sure that at least some of the people pulling the top tax rate were evenly distributed along the income spectrum. For the scheme to work, there has to be a realistic possibility for an even top, top earner could end up in a 15% tax bracket. But the problem is if just one person making say $500 million or more a year pulls a 15% tax bracket, that could lead to lower overall tax revenue, even if nearly everyone else ends up in paying a 75% income tax.

The way to get around this, though, could be to hold multiple tax lotteries in each income bracket. So that someone ends up with a low rate and a high rate in say the $375,000-to-$500,000 group as well as the $5 million-to-$10 million range.

Another objection to the idea of tax lotteries would be a question of whether it is fair. How can even a rich person plan their life if they don’t know whether they will be taking home 85% or 25% of their bucks above $500,000. How will they know if year to year they can afford the mortgage payments on their $20 million pad in the Manhattan and their $40 million house in the Hamptons.

The answer to this objection is that top earners already often have to plan around large variable incomes. On Wall Street, top bankers routinely get 80% of their pay in what is supposed to be a variable year-end bonus. The same is true to an extent for top salesmen and other rainmakers at other firms. Small business owners have long had to do wealth planning and estate planning around the fact that they don’t know how much income they will generate each year. A variable top tax rate would add a little bit more variability, but top earnings are living with that already.

There is indeed a lot of interest in how we should tax the rich. I have often been surprised at how many people are against raising taxes on the super rich, despite the fact that very few of us ever reach that level of wealth. But the focus on what the rich should be taxed is an important question. Afterall, with fewer and fewer people making the mega bucks these days, just where is tax revenue going to come from?