By Tax Credits (CC BY 2.0)
Where are top income tax rates heading? The answer may depend on how Americans view the rich and the reasons behind high-end income inequality. Are the 1% and 0.1% and 0.01% pretty much deserving or undeserving?
Or to put it another way: if you believe — mostly — that macro forces such as technology and globalization have boosted top incomes by allowing highly talented and educated individuals to manage or perform on a larger scale, then you might be less inclined to support higher top marginal rates. But if you believe the “rich getting much richer” phenomenon is mostly driven by compliant corporate boards overpaying CEOs and a breakdown of social norms against exorbitant pay, then you might favor sharply higher tax rates.
So where are we today? In a new Harvard Business Review essay, Roger Martin argues that American attitudes toward taxation and the rich have moved through four historic eras. From 1932 though 1981, for instance, top tax rates rose from 25% to a high of 94%. During that period, high incomes were thought to be something obtained by owning assets rather than through work. Martin: “According to the theory, most rich people were basically rentiers and their income from owned assets could — and should — be taxed at very high rates with no adverse impact on their behavior or the economy.”
Since then, a different economic theory and attitude has held sway, resulting in much lower top tax rates (even with the Obama tax hikes.) Recognizing that the US had become a knowledge-driven economy, “lawmakers finally abandoned the prewar assumption that all rich people were rentiers and recognized that at the prevailing rates talented people were being put off work.” So taxer were lowered to encourage more work.
So will the current era continue? Martin doubts it:
In times of crisis, America has shown that it asks the super-rich to pay a lot more than the rich and I think this will happen based on the feeling that it is a time of economic crisis in America. Also, although applying a rich-as-rentier theory (implying tax rates in the 70% plus range for high incomes) isn’t really fit for purpose in a talent-driven economy, it’s also not justifiable to have a maximum rate that doesn’t distinguish between a mid-level executive and a hedge fund manager.
My bet is that the Fifth Era will look a lot like the early Third Era — after the height of the Great Depression but before the inception of WWII. That is, $10 million earners paying in the 75% range, $1 million earners in the 50% range and $500,000 earners in the 35% range.
How high or low the rates of the Fifth Era structure will be will depend, I think, on whether talent is seen as engaging primarily in trading value or primarily in creating value for their fellow citizens (in terms of better products and services and more jobs). If it is the former, they will be taxed more highly as unworthy rentiers and there will be little concern for incentive effects. If the latter, they will be taxed as important economic assets whose incentives must not be dampened. Right now, sentiment is trending more in the former direction than in the latter — a perception that the talented people on the Forbes 400 list have done little to dispel.
I will admit that given the financial crisis, Occupy Wall Street, and the incessant media coverage of the income inequality issue, Martin’s conclusion may intuitively feel right. Then again, national Democrats aren’t running on raising top tax rates further. Nor would I expect Hillary Clinton to do so in 2016. I doubt left-liberal pols think America is ready to embrace pre-Reagan tax rates (although left-liberal economists have given them the academic go-ahead.) Left-wingers can’t even do that in France.
Indeed, polls don’t suggest any unusual urge to sock it to the rich. Take a look at these two Gallup surveys. The first, from earlier this month, shows banks — I would guess that people see rich bankers as less deserving than tech entrepreneurs — with a net positive approval rating. The second, from last year, shows that while Americans favor income redistribution, not any more than they did 30 years ago despite rising high-end inequality:
People have mixed feelings about inequality, what’s driving it, and how it’s affecting the economy and their chances for success. I think people buy into the talent-driven explanation yet also think the game might be rigged for some at the top. That is certainly how I view it, given a world of both technological change and Too Big To Fail (plus other cronyist policies). But at this point, growth rather less inequality seems to what voters prefer. And while they may not think tax cuts for the rich help growth, they don’t yet think massive new tax hikes will help either (via GlobalStrategyGroup).
Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.