Democrats Face an Upper-Middle-Income Trap

The Internal Revenue Service building stands in Washington, D.C., May 27, 2015. (Jonathan Ernst/REUTERS)

One common argument for a sharp increase in the top marginal tax rate is, as I observed last week, essentially punitive. If you are concerned about the concentration of income and wealth per se, you might favor higher marginal tax rates even if you expect that they will provide a disincentive to earning taxable income and to savings and investment, perhaps on the grounds that any hit to growth will disproportionately burden high-income households. It is worth noting, though, that even those who’d embrace this punitive case generally do so within limits. To those in the mushy muddle, some reduction in growth might be acceptable, but not too much, especially if low- and middle-income households get caught in the crossfire.

Consider that the case for steep increases in the top marginal tax rate rest on the assumption that, for one, they won’t have a meaningfully negative impact on the creation of new ideas that drive increases in economic output. Yet there is at least some reason to believe otherwise. Recently, Charles I. Jones offered a preliminary thought experiment about what we’d expect to happen if the creation and implementation of new ideas were influenced by the top tax rate. “In particular,” Jones hypothesizes, “high incomes are the prize that motivates entrepreneurs to turn a basic research insight that results from formal R&D into a product or process that ultimately benefits consumers. High marginal tax rates reduce this effort and therefore reduce innovation and the incomes of everyone in the economy.” Needless to say, Jones’s exercise in modeling hasn’t changed the minds of those who want cold, hard empirical proof. Enter the economists Ufuk Akcigit, John Grigsby, Tom Nicholas, and Stefanie Stantcheva, who released a working paper that finds that “taxes matter for innovation: higher personal and corporate income taxes negatively affect the quantity and quality of inventive activity and shift its location at the macro and micro levels.” Again, the work of Akcigit et al. is hardly the last word, but it bears close attention as the tax wars proceed.



My suspicion, and here I strongly agree with Ramesh, is that the recent emphasis on raising the top marginal tax rate for multimillionaires is driven in in no small part by Democratic coalition politics. While most market democracies with extensive social-insurance programs and high levels of redistribution finance their safety net with broad-based taxation, as opposed to steeply-progressive taxation, moving in that direction is hard for Democrats to reconcile with their growing reliance on tax-averse upper-middle-income voters.


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