Tax Policy – How Much Revenue Would a 70% Top Tax Rate Raise? An Initial Analysis
Congresswoman Ocasio-Cortez recently discussed her support for taxing incomes over $10 million at 70 percent. Her goal is to raise additional revenue to fund new federal priorities, such as a “Green New Deal,” which aims to convert the U.S. economy to fully renewable energy. There has been discussion over how much such a proposal would raise in revenue. For example, the Washington Post published estimates stating that a top rate of 70 percent could raise a little more than $700 billion over a decade. However, current estimates do not account for behavioral effects, which are important to evaluate a policy like this. This is because a tax rate that high could encourage individuals to shelter their income, thus reducing potential revenue from this proposal.
Details of the Proposal
So far, Congresswoman Ocasio-Cortez has not been specific about her proposal for a 70 percent tax rate. However, her comments imply that she wants to add an eighth tax bracket of 70 percent on incomes over $10 million. What this means is that individuals would need to pay 70 cents for every dollar they report in taxable income over $10 million. It’s not clear yet whether it would apply only to ordinary income (wages, salaries, interest, business income), or if it would apply to all income (ordinary income plus long-term capital gains and qualified dividends).
Given the uncertainty around what income this top tax rate would apply to, we estimated two potential proposals. Proposal 1 would add an 8th tax bracket of 70 percent over $10 million on ordinary income. Qualified income would remain taxed at a top rate of 20 percent. Proposal 2 would add an 8th bracket of 70 percent over $10 million but apply it to all income—both ordinary income and qualified income. Both proposals would be applied to taxable income over $10 million and the brackets would not be adjusted for filing status. The threshold would remain $10 million whether a tax filer was single or married filing jointly.
| Proposal 1 | Proposal 2 |
|---|---|
|
Add an 8th tax bracket at 70 percent on taxable income over $10 million for all filing statuses. Applies to only ordinary income. Bracket widths are not adjusted for filing status. |
Add an 8th tax bracket at 70 percent on taxable income over $10 million for all filing statuses. Applies to ordinary income and qualified income. Bracket widths are not adjusted for filing status. |
Conventional Estimate
We estimate that applying a new 70% tax rate on ordinary income over $10 million (proposal 1) would raise about $291 billion between 2019 and 2028. While taxpayers would react to proposal 1 by reducing taxable income, the effect wouldn’t be significant. As a result, the proposal would still raise revenue each year over the budget window.
Counterintuitively, if the 70 percent tax bracket were to apply to all income over $10 million, the proposal would raise much less revenue. We estimate that proposal 2 would raise $51.4 billion between 2019 and 2028 and lose revenue in the first two years of its enactment.
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Note: Both Proposal 1 and 2 would apply a 70 percent tax on incomes over $10 million. Proposal 1 would only apply the new tax to ordinary income. Proposal 2 would apply the new tax to all income (ordinary plus capital gains and dividends). Source: Tax Foundation General Equilibrium Model, October 2018 |
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| 2019 | 2020 | 2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2019-2028 | |
|---|---|---|---|---|---|---|---|---|---|---|---|
|
Proposal 1 |
22.2 | 23.9 | 25.4 | 27.3 | 29.5 | 31.8 | 34.3 | 29.4 | 32.8 | 35.1 | 291.7 |
|
Proposal 2 |
-10.4 | -4.6 | 4.3 | 5.6 | 7.1 | 8.7 | 10.4 | 8.1 | 10.2 | 12.0 | 51.4 |
The reason why a 70% tax rate on all income over $10 million would raise very little revenue is due to how taxpayers would react to the much higher tax rate on capital gains. Under current law, capital gains are taxed only when they are “realized” — that is, when the assets are sold. This means that individuals can effectively choose when to pay the tax. As a result, capital gains are very responsive to the tax rate.
For capital gains over the $10 million threshold, the tax rate would increase from the current 23.8 percent (the 20 percent statutory tax rate plus the 3.8 percent net investment income tax) to 73.8 percent. That is a 210 percent increase. This would result in a significant decline in capital gains realizations that would otherwise be subject to the new tax rate. We estimate that realizations that would be subject to the $10 million tax bracket would be permanently 77 percent lower than they otherwise would have been. As a result, federal income tax revenue from capital gains would fall and offset a large portion of the additional tax revenue from taxing ordinary income.
Dynamic Revenue Estimate
On a dynamic basis, we estimate that Proposal 1 (applying the top tax rate to only ordinary income) would raise $189 billion between 2019 and 2028. In contrast, we estimate that Proposal 2 would end up losing $63.5 billion over the same period.
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Note: Both Proposal 1 and 2 would apply a 70 percent tax on incomes over $10 million. Proposal 1 would only apply the new tax to ordinary income. Proposal 2 would apply the new tax to all income (ordinary plus capital gains and dividends). Source: Tax Foundation General Equilibrium Model, October 2018 |
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| 2019 | 2020 | 2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2019-2028 | |
|---|---|---|---|---|---|---|---|---|---|---|---|
|
Proposal 1 |
19.3 | 17.8 | 15.9 | 17.3 | 19.0 | 20.7 | 22.8 | 16.4 | 19.0 | 20.7 | 189.1 |
|
Proposal 2 |
-13.5 | -11.1 | -5.8 | -5.2 | -4.5 | -3.7 | -2.7 | -6.6 | -5.7 | -4.7 | –63.5 |
Proposal 1 would increase the marginal tax rate on wage income, which would reduce hours worked by taxpayers impacted by this tax bracket. In addition, the cost of noncorporate capital would rise as profits from noncorporate businesses would be taxed at a much higher rate. Both effects would narrow the income and payroll tax base, resulting in less additional revenue than on a conventional basis.
Proposal 2 would have similar economic effects as proposal 1. The marginal tax rate on wages and the cost of capital for noncorporate businesses would both be higher. In addition, proposal 2 would also impact the corporate cost of capital by applying the higher tax rate to capital gains and dividends. However, that additional impact due to the taxation of capital gains and dividends would be small. Individuals who react by deferring capital gains would greatly reduce their effective tax rate or, ultimately, completely avoid the tax through step-up in basis at death.
The reason proposal 2 ends up losing revenue is not because the negative dynamic feedback is particularly large. In fact, the dynamic feed back of proposal 1 and proposal 2 are very similar. The reason proposal 2 ends up losing revenue is because the tax base, on a conventional basis, is narrower to start with due to much lower capital gains realizations. Once the negative dynamic revenue feedback is incorporated, revenue for the federal government ultimately falls.
Methodology and Modeling Notes
We use the Tax Foundation General Equilibrium Tax Model to estimate the impact of tax policies. The model can produce both conventional and dynamic revenue estimates of tax policy. The model can also produce estimates of how policies impact measures of economic performance such as GDP, wages, employment, the capital stock, investment, consumption, saving, and the trade deficit. Lastly, it can produce estimates of how different tax policy impacts the distribution of the federal tax burden.
Our estimates assume that taxpayers will adjust their behavior to the new tax rate. There are two behavioral effects important for analyzing this proposal.
The first important behavioral effect is how taxable income, in general, responds to taxation. When faced with an increase in taxes, individuals will respond by adjusting their taxable income downward to avoid the tax.[1] The responsiveness of taxable income to the tax rate is typically expressed as an elasticity. These elasticities of taxable income (ETI) are expressed as the percent change in taxable income relative to the percent change in the “net-of-tax-rate.” For example, a proposal may increase the top tax rate from 37 percent to 50 percent. This means that the net-of-tax rate would fall by 20.6 percent.[2] With an elasticity of .25, we would expect taxable income to fall by 5.1 percent.[3] In the literature, ETIs are not typically very high. A 2012 review of the literature finds that they range from 0.12 to 0.4 with a mid-point of 0.25. [4] For this analysis we use the mid estimate of 0.25, which is consistent with other groups.[5]
The second important behavioral effect is how capital gains realizations respond to changes in tax rates. Under current law, capital gains are only taxed when realized. As a result, taxpayers can choose when to realize their gains and pay the tax. This makes capital gains significantly more responsive to tax rates than other types of income. This behavior is also expressed as an elasticity. An elasticity of -0.9 means that for a 10 percent change in the capital gains tax rate, realizations would fall by roughly 9 percent (10% * -0.9). There is a wide range of estimates in the literature with a distinction between short-run realizations behaviors and long-run realization behaviors. Elasticities can be as high (in absolute value) as -6.4 and as low at -0.3. That Tax Foundation’s preferred elasticities are -1.1 in the first year, -0.9 in the second year, and -0.7 in all subsequent years, which are consistent with other group’s assumptions.[6]
In modeling the proposal’s impact on the labor force, we used an elasticity of 0.22, which is lower than our typical elasticity of 0.3. This lower elasticity is consistent with CBO’s elasticity for high-income workers and reflects the belief the high-income wage earners are less sensitive to marginal tax rates than lower-income wage earners and especially secondary earners.[7]
Given the limited amount of details about the proposal, this is a preliminary analysis. The ultimate impact of the proposal will depend on its final details.
[1] Aparna Mathur, Sita Slavov, and Michael Stain, “Should the Top Marginal Income Tax Rate Be 73 Percent?” http://www.aei.org/wp-content/uploads/2012/11/-should-the-top-marginal-income-tax-rate-be-73-percent_085518416524.pdf
[2] (1-50%)-(1-37%)/(1-37%)
[3] -20.6% * 0.25
[4] Emmanuel Saez, Joel Slemrod, and Seth H. Giertz, “The Elasticity of Taxable Income with Respect to Marginal Tax Rates: A Critical Review.” Journal of Economic Literature. 2012.
[5] Tax Policy Center, “Brief Description of the Tax Model,” Updated on August 23, 2018. https://www.taxpolicycenter.org/resources/brief-description-tax-model
[6] Ibid. Also see: Tim Dowd, Robert McClelland, and Athiphat Muthitacharoen, “New Evidence of the Tax Elasticity of Capital Gains,” June 2012. https://www.cbo.gov/sites/default/files/112th-congress-2011-2012/workingpaper/43334-taxelasticitycapgains.pdf
[7] Congressional Budget Office, “How the Supply of Labor Responds to Changes in Fiscal Policy.” October 2012. https://www.cbo.gov/sites/default/files/112th-congress-2011-2012/reports/43674-laborsupplyfiscalpolicy.pdf
Source: Tax Policy – How Much Revenue Would a 70% Top Tax Rate Raise? An Initial Analysis
Dalip Malik CPA