Wednesday, September 14, 2011

The Jobs Impact of a High Top Tax Rate

President Obama wants to cut payroll taxes and pay for it in part by raising the top Federal income tax rate.

Cutting payroll taxes is long overdue. You get less of what you tax. If you tax jobs - and that's what a payroll tax is - you get fewer jobs. Also, a middle-class worker is more likely to spend the money from a tax cut than someone earning $500,000 a year.

What would the effect be of a higher top Federal income tax rate? Tony Phillips in his blog on compares top marginal tax rates and job growth during the period 1925-2010.

The top tax rate was below 40 percent in 31 of these years (1925-31 and 1987-2010). The average top tax rate was 33.3 percent. Job growth averaged 0.94 percent. (GDP growth averaged 3.6 percent.)

The top tax rate was 70-94 percent during the other 45 years! The 94 percent rate was in the two peak wartime years of 1944-45. The average top rate was 81.5 percent. The average rate of job growth was 2.6 percent, 2.8 times the average growth for the low-rate years. (GDP growth during the high-top-tax-rate years averaged 8.6 percent, 2.4 times the average GDP growth rate during the low-rate years.)

Meanwhile, in the low-top-tax-rate years, inequality of income has increased. This has hurt consumer demand, which is the bulk of GDP. The payroll tax has become a huge share of Treasury income, but it tops out. Without a higher top rate, our income tax structure is highly regressive, as Warren Buffett has famously complained.

The latest year when a higher top tax rate, 70 percent, was in effect was the last year of the Carter Administration. Phillips says:
[In 1980, when] America's top marginal income tax rate was 70%, that rate applied to earners with incomes of $215,400 or more. In 2011 dollars, that equals $590,000. Under a 1980 scheme, only a tiny fraction of Americans would pay the top marginal tax rate.
So Obama's proposed tax reforms look good from both sides. Cutting payroll taxes will boost demand and create jobs. Raising the top income tax rate to pay for the cut reduces the severely regressive tax sttucture and seems historically to be associated with more job creation than occurs under the present low-top-rate system introduced during the Reagan administration.