What if the Top Tax Rate was 99.99%?

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What should be the top tax rate for America’s wealthiest citizens? I recently wrote a post arguing why we should think about raising tax rates for the super wealthy. This evoked a range of responses from commenters. tnnumbers wrote:

As others have mentioned, the wealthy no longer limit their investments to America, so even taking into account federal government bloat, taxing the rich is more likely to put American earnings to work in America,

ivan256, wrote:

Lies, damned lies, and statistics. If this section of the article got you nodding your head in agreement, well… I have a pile of apples here… Would you like to be enraged that they’re nothing like oranges? Let’s dissect this pile of bad math and bad logic piece by piece.

And one commenter actually wrote that he hoped a close family member of mine would soon contracted a horrific, incurable disease:

Stephen, you are an idiot.

OK. So we don’t seem to agree on whether taxes should go up or down for the super rich. But you would think economists would have an answer. Nope. Seems that even economists who tend to have the same area of expertise can’t come to any agreement either.

A blogger for Ezra Klein’s policy blog over at the Washington Post recently asked a number of economists what they thought the top tax rate for the wealthiest Americans should be, and the answers were all over the map. Emmanuel Saez, a prof at Berkeley and a tax expert, said the top federal income tax rate, currently 35%, should be raised to 69%. Larry Kudlow, a TV show host and former Wall Street economist (for the belated Bear, I believe), who likes to think of himself as a tax expert, says 15%-20%, max.

Missing from the group of economists that the blogger asked was anyone that specializes in behavioral economics. That seemed to be a glaring omission. The claim that top tax rates slow the economy because it disincentives people to work and invest seems to me at its heart to be a behavioral one. So I decided to e-mail a few behavioral economists to see what thoughts they had on how tax rates affect people’s desire to work. And again, while this group would agree on a lot of things, when it comes to taxes not so much.

My basic assumption was that behavioral economists would see the question of how people react to tax rates as a question of relative wealth. We all want to be wealthier than the next guy. So the no mater what the tax rate was, we would continue to work because goal is not the money itself, but standing. So here’s the e-mail I sent out:

At what point do you think tax rates make work less appealing? It seemed to me this was more a behavioral question and not a traditional economics questions. I would think people would work until tax rates hit 99.99%, because even if I get only 0.01% of my last bit of income I’m still wealthier than the next guy, which is what I care about anyway. Please let me know if you have any thoughts on this. Thanks.

Dan Ariely, a professor at MIT’s business school, said he generally agreed with me that high tax rates would not cause people to work any less. (looks like he even decided to stick a generically named graduate student on the topic):

What an interesting question.

My guess is that it depends on whether we consume things in an absolute way ( in which case we will work less hard when the tax rate goes up) or in a relative way (in which case we will keeping working as hard because we are just motivated to show others that we have more then they do.

In a world like the one we have where we have a lot of things that we can buy to show others how much money we have relative to them (vars, houses, iPads etc) I suspect that the relative consumption is more important so I suspect that even at a very high rate people will still work….

Guy — at some point lets think about experimenting with when people think they will stop working and when they will actually stop working and how this will depend on whether others will see the outcome of their effort or not….

Irrationally yours

However, here’s what I got back from Chicago Business School’s Richard Thaler, who many see as one of the leading scholars of behavioral economics:

Your intuition is not right.  At very high rates people just resort to barter.  I think that the posts you have from Saez and others seem right to me.

At first Thaler appears to be disagreeing with me. But he really has just punted on my question. I wasn’t really asking about the effect of 99.99% tax rates. I was just using that as an extreme example of a high tax rate. And Thaler is not saying people will stop working at high tax rates. They will just conduct their quest for wealth in ways that will be harder for the government to track and tax. That will result in lower tax revenue, but not slower economic growth rates or a decreased desire to earn money. So call Thaler middle of the road on taxes. Raise them, but not too much.

Lastly, David Laibson from Harvard had this to say:

the available evidence implies that on average people do work less as tax rates go up

the evidence is muddy, but even a skeptical reader of that literature, like me, recognizes that almost all of the research finds that higher tax rates reduces the amount of work that people do

of course, that doesn’t mean that tax rates should be low

saez (one of the two experts in the list you pointed me to) is probably right that raising the tax rate to 70% would maximize revenue next year

but saez’s answer doesn’t mention the dynamic consequences of high tax rates

mankiw’s answer and feldstein’s answer have a great deal of merit, since they point out that short-term revenue maximization is not our social goal

if we shoot ourselves in the foot in the long-run, that counts as bad policy

but i know that saez would also say that the policy goal should not be short-run revenue maximization

the goal is to improve general human welfare in the short-run and the long-run, which almost surely requires a tax rate well below 70%

Laibson’s response suggests that given the choice he would probably leave tax rates where they are, or even consider lowering them. So there you have it. Three behavioral economists and three different views of what tax rate the super wealthy should pay. No wonder the tax debate never ends.

BONUS: A cartoon by way of Barry Ritholtz on the subject. Enjoy.