Ocasio-Cortez’s 70% Tax Idea Isn’t Very Radical

Noah Smith
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Ocasio-Cortez’s 70% Tax Idea Isn’t Very Radical

(Bloomberg Opinion) -- The other day, freshman Congresswoman Alexandria Ocasio-Cortez made headlines (yet again) with a bold proposal — a 70 percent marginal tax rate on income of more than $10 million a year. This tax, Ocasio-Cortez declared, would fund her so-called Green New Deal, a still-developing plan to eliminate fossil-fuel energy by 2030 and lower inequality.

“Call me a radical,” she declared. Let's hope she was being tongue-in-cheek, because the plan isn’t really that radical. The top marginal tax rate was 73 percent in 1920, more than 90 percent during the 1950s, and 69 percent in 1981:

Ocasio-Cortez’s plan would thus be a return to the 20th century norm — in fact, not even that, because the cutoffs for those very high tax brackets were often much lower than $10 million, even after adjusting for inflation.

Conservatives and anti-tax activists, naturally, were quick to condemn her idea. But as Paul Krugman pointed out, the plan would be unlikely to cause much damage to the economy.

Theoretically, high taxes can make people work less — if a well-to-do person takes home only $5,000 an hour instead of $7,000, he might cut back on the number of hours he works. But in real life the effect is probably very small. First of all, this cohort tends to have full-time salaried jobs. They don’t get paid by the hour — their reward for an extra hour of work is advancement for themselves or the entities for which they work. Higher taxes are unlikely to reduce those incentives much. And they’re also unlikely to discourage people from wanting to be leaders in the first place.

Economics research bears this out. Income taxes in general discourage people from working only a little bit. For the well-off, the effect is probably even less substantial. Economists Christina Romer and David Romer looked at top tax rates during the 1920s and 1930s, and found that although the big changes in top tax rates did lower pretax income for high-earners a bit, the effect was quite small. For this reason, economists Peter Diamond and Emmanuel Saez (the former of whom is a Nobel laureate) calculate that in order to maximize social welfare, the optimal top tax rate for incomes higher than $300,000 — a much lower cutoff than the one proposed by Ocasio-Cortez — should be about 73 percent. That calculation relies on the idea that an additional dollar of income is more meaningful for the poor than for the well-to-do.

So Ocasio-Cortez’s tax plan isn’t radical at all, and almost certainly won’t damage the economy in any significant way. But those who expect the plan to yield a bounty of tax revenue for a Green New Deal or other major spending programs are likely to be disappointed, because the proposed tax hike by itself wouldn’t raise much revenue.

If you simply calculate the amount of money the tax would raise if the wealthy paid all of the tax, it would yield roughly $72 billion a year. That would increase federal tax revenue by about 3.6 percent — more than nothing, but not a huge amount either. It would certainly not be nearly enough to pay for Ocasio-Cortez’s Green New Deal, which could easily cost more than 13 times that amount. Wealthy people have eye-popping incomes, but there really aren’t that many of them.

The actual amount of revenue raised would almost certainly be much smaller. This is because the well-off have many ways to avoid paying income taxes, using loopholes that we should think about closing up.  Many of these loopholes involve changing ordinary income to capital gains, which are taxed at much lower rates, so raising the capital gains tax will be crucial.

What’s more, history demonstrates how hard it is to raise tax revenue with high top-bracket tax rates. Even in the days of extremely high marginal tax rates on income brackets much broader than what Ocasio-Cortez proposed (as well as higher taxes on corporations and capital gains), the share of the nation’s income that went to federal taxes was about the same as it is now:

In other words, a dramatic expansion of federal tax revenue would require much more than what Ocasio-Cortez is proposing. It would require an overhaul of the corporate and capital-gains tax systems, higher rates on a much broader range of high earners, and probably wealth taxes as well. It would require a huge amount of political will and a sustained policy-making effort over a number of years.

As for reducing inequality, taxes on ordinary income higher than $10 million would only serve to compress the distribution a bit at the top — to bring the rich and the super-rich slightly closer together. It would do nothing to reduce the yawning disparities between the well-off and the middle class, much less the poor.

So Ocasio-Cortez’s proposal is hardly outside the economic mainstream. If big new programs like a Green New Deal are to be made a reality, or if inequality is to be reduced, it’s only a start.

To contact the author of this story: Noah Smith at nsmith150@bloomberg.net

To contact the editor responsible for this story: James Greiff at jgreiff@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Noah Smith is a Bloomberg Opinion columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.

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