Study: The “optimal tax rate on the highest earners is in the vicinity of 70%”

This comes via Paul Krugman, but the research is not his. The source is a paper by Peter Diamond and Emmanuel Saez (pdf).

The headline is the news, or at least part of it. Krugman:

Using parameters based on the literature, D&S; suggest that the optimal tax rate on the highest earners is in the vicinity of 70%.

That’s surprisingly close to the Nixon-era Top Marginal Tax Rate of 75% (down from that job-killing Eisenhower-era rate of 91-92%). That measure of max tax takes into account the “they’ll go Galt” factor, by the way; an offset for that effect is built into the calculation.

(It’s not clear whether the 75% number is the total tax, or just the top rate on the highest dollars earned. It’s almost certainly the latter, since that’s the way we do taxes in the U.S. but still, I wanted to add that caution.)

The second point that’s interesting about this paper — aside from the headline number — is the meaning of the phrase “optimal tax rate.” What does “optimal” mean? Krugman again:

In the first part of the paper, D&S; analyze the optimal tax rate on top earners. And they argue that this should be the rate that maximizes the revenue collected from these top earners — full stop.

Why isn’t the rate then 100%? The answer is what I noted above, that too high a tax will either cause earnings to drop or drive part of the economy of the very wealthy to go underground (into a kind of black-velvet, jewel-encrusted market). Around 70% represents the calculated balance point where Max Tax is created.

As to why we apply Max Tax to everyone but the rich — well, that has to do with our 18th century belief that God (conveniently) shows the Elect his predestined favor — and their future place at his right hand — by rewarding them with riches on earth. Unlike all those other sinners our Angry God holds in his hand, ready to fry at a whim.

How convenient for the wealthy that God chose that method, and especially interesting that the wealthy were first to discover it. (Hmm.)

But that gets us into the discussion of Erich Fromm’s seminal study of the modern sado-masochistic (i.e., authoritarian) personality — the discussion I haven’t written yet. So we’re not going there. (Sorry.)


Gaius Publius is a professional writer living on the West Coast of the United States.

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