Posts Tagged ‘Marginal tax rates’

A look at taxes in perspective

December 11, 2012
Double click to enlarge

Double click to enlarge

If we return to Clinton-era tax rates, taxes will still be low by historic standards.

Keep in mind that the tax rates shown are only the top marginal rates, paid on income above a certain threshold.  Most people, including the very rich, are taxed at a lower overall rate.

Hat tip to The 21 Blog.

Why higher taxes might be good for the economy

December 12, 2011

Corporate executives say that the top rates on income taxes have to be kept low in order to give them an incentive to invest and create jobs.  But when you stop and think about it, the incentive is the exact opposite.  The lower the top income tax rate, the more incentive there is to take money out of the business.  The higher the top income tax rate, the more incentive there is to put money back into the business, since reinvested profits aren’t taxed.

This is obvious now that I think about it, but I didn’t see it until an economist named Mike Kimel pointed it out.  His study of the historical data indicates that the optimal top federal income tax rate is 65 percent.  Here’s how he thinks this works.

… … There is a notion that raising tax rates will reduce people’s willingness to work… which is only true above certain thresholds. (That threshold, of course, varies per individual.)  As anyone who has ever had a business will tell you (when they’re not busy demanding tax reductions), you don’t pay taxes on income from the business if you turn around and reinvest that income.  (An accountant would talk to you about decreasing your tax liability by increasing expenses which amounts to the same thing.)  You only pay taxes on that income you take that income out, presumably for consumption purposes.

So to simplify, consider an example.  Is a successful businessperson more likely to take money out of the business if his/her tax rate is 70 percent or if it’s 25 percent?  In general, a person is more likely to take that money at 25%, as there’s less of a penalty. At 70 percent tax rates, there is more of an incentive to reinvest in the business, creating more growth in the business in subsequent years, and more economic growth thereafter.  Seventy percent tax rates are more likely to generate faster economic growth than 25 percent tax rates precisely because people are self-interested and the higher tax rates induce people to continue investing in things they do well.

(Of course, tax rates can get too high. At 95 percent, people will reinvest almost every dime, even if they have exhausted every good investment opportunity they have. Thus, to avoid taxes they’ll be making lousy investments which in turn slow economic growth.)

Source:  Presimetrics.

In addition to the things Kimel mentioned, the risk-reward tradeoff on investment by rich people is much the same no matter what the marginal rate.  Higher rates decrease risks as well as returns.  You get to keep less of your marginal profit, but you get a more valuable tax deduction if you have a loss.

Now I don’t think that marginal tax rates are the main reason for high or low economic growth.  Businesses expand when there are paying customers for their products, not otherwise.  But it is a historical fact that, in the United States, business growth since the Great Depression has been greatest when the top tax rate has been highest.  And it also is a historical fact that since the Reagan revolution in taxes, there has been an increase in corporate executives and financiers who get rich not by creating value, but by transferring wealth from enterprises into their own pockets.

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