2.7.18

THE DISINCENTIVE EFFECTS OF HIGH MARGINAL TAX RATES.

The likes of Senator Bernie Sanders are still nostalgic for those Eisenhower Regency top marginal tax brackets of 90%.  Those are gone from the tax code, but there are marginal tax rates going on 78%, according to Greg Mankiw.  They're present at the lower quintiles of the income accounts, as people transition from public assistance to paid work.

The possibility of the tax code contributing to keeping poor people poor (the term of art used to be notch, as your after-tax income would suffer a major dip once your paid work rendered you ineligible for public assistance) has long been a political economy thing, and that's supposedly one of the merits of a properly calibrated negative income tax, or an earned income tax credit, although the idea of starting with a $4000 tax credit which diminishes with income from paid work still puts voters and some politicians off.

David "Voluntary Xchange" Tufte has worked through the tax and transfer policies as they currently stand with the following analysis.
Most of us are comfortable living in a society in which at least something is transferred from the richer to the poorer. So we shouldn’t expect that number to be zero. And, we’re pretty used to paying a chunk of our income in federal income tax, having FICA withdrawn from our paychecks, sending more to states and localities in income and real estate taxes, and then paying sales taxes on top of that. Total those up, and you’re in the 40% range for many people. Note that this is an average rate: the math gets a little arcane, but effective marginal rates can diverge quite a bit from average rates, and a progressive tax system puts them on the high side. The bottom line is that we shouldn’t jump too quickly to presuming that my 79% (or Mankiw’s 76%) is too high.

A better way to assess this would be to figure out the effective marginal tax rates for all upward shifts. So, it’s 79% to go from lowest to second lowest, and then 73% to make the jump from second lowest to the middle quintile, 59% to go one step further, and then 44% to go from the second highest to the highest quintile. Now we’re getting somewhere. Our system as it currently stands punishes everyone for working more, harder, and better. But don’t forget that this is OK: it means we’re all chipping in to help the less fortunate. The thing is, we punish the poor who work more, harder, and better more than we punish the upper middle class who choose to do that. Is it any wonder that there’s a perception that the upper middle class has more strivers?

That answers my second question. Yes, 79% is too much to take from the poor who are trying to improve their lot because we don’t take as much from those who are better off and trying to do the same thing.
Filling in those notches, to use the older terminology.  "It turns out that getting the incentives right for the poor is mostly about making the middle class more attractive."

No comments: