What Taxes Should Be

This is what economic research says about our taxes:

• The top U.S. income tax rate is currently well below best estimates of the optimal rate for revenue maximization.
• Recent research implies a revenue-maximizing top effective federal income tax rate of roughly 68.7 percent. This is nearly twice the top 35 percent effective marginal ordinary income tax rate that prevailed at the end of 2012, and 27.5 percentage points higher than the 41.2 percent rate in 2013.2 This would mean a top statutory income tax rate of 66.1 percent, 26.5 percentage points above the prevailing 39.6 percent top statutory rate.
• Tax reform that broadens the tax base and minimizes tax avoidance opportunities actuallyincreases the revenue-maximizing top marginal tax rate. This means that base-broadening tax reform and higher marginal rates should be seen as complements, not substitutes.
• Analyses of top tax rate changes since World War II show that higher rates have no statistically significant impact on factors driving economic growth—private saving, investment levels, labor participation rates, and labor productivity—nor on overall economic growth rates.
• Both short-run demand-side and long-run supply-side growth effects stemming from top tax rate changes are extremely modest. Thus, related “dynamic” revenue “leakages” stemming from reduced economic activity following top rate increases are small as well. Indeed, the net revenue feedback of the 2001–2004 tax cuts was recently estimated at recouping just 1 percent of their scored cost.
• Historically, decreases in top marginal tax rates have widened inequality of both pre- and post-tax income. This has been interpreted by some economists as marginal rate reductions providing a higher payoff to rent-seeking (i.e., using influence to “bargain” a higher share of income at the expense of other workers).
• Today’s economic context of a depressed U.S. economy, political pressure to prematurely reduce near-term budget deficits, and ever-widening income inequality actually strengthens the case for raising top marginal tax rates. There remains substantial scope for further raising top rates toward the revenue-maximizing levels estimated by the best economic research.