There is a common narrative in our culture that high marginal income tax rates are bad for the economy. People who are incredibly wealthy say this fairly often. Both Bill Gates and Michael Dell have said so at the World Economic Forum meetings in Davos Switzerland.
However, it’s not true.
This blog post is my attempt to explain WHY this is not true. Why high marginal tax rates not only do not harm the economy, they are are in fact good for the economy.
There is talk of a 70% rate on the top margin of income, and in this post I explain why that would be good for the overall economy.
Table of Contents
First, what are marginal tax rates?
There is a great YouTube video from Vox that does a fantastic job of explaining this in 2 minutes and 47 seconds. Before you watch the video that where they say “brackets” I’m saying “margin”.
So why are high marginal income tax rates good for the economy?
This idea was taught to me in an Economics class at a community college in 1983-ish. It was so compelling I remembered it decades later.
A few decades later some people were having an online discussion about taxation (on Google Plus if you remember that).
I chimed in with the explanation below.
I started by saying I’m not an economist, but I learned this in an economics class 25 or 30 years earlier. Almost immediately someone else chimed in, said they were an economist, and I was the only person in the entire discussion thread to understand how this works.
I mention this not to brag, but give some credence to the argument, because I’m about to say something that most people think initially sounds crazy.
High marginal income tax rates are not about collecting taxes
They’re about legally avoiding taxes, through spending.
For purposes of this example, let’s pretend there are only two tax brackets (the video above uses actual US tax brackets effective in 2018).
Our two tax brackets are:
- From $0 in income to $5M in income you pay 10%.
- From $5M and up you pay 70%.
Now let’s assume you’re very highly paid. Your compensation is $8M per year.
For your first $5M, you keep $4.5M. For your next $3M, you keep $900K.
This is a significant loss of value to you for that top $3M due to the 70% tax rate.
They’re about SPENDING into the economy
You don’t want to lose that value. Your employer presumably values you (or else why would they pay you so much) and they also don’t want yo to lose that value.
So, they pay you only $5M, and the other $3M is provided to you in various form that provide value to you AND are tax deductible to them.
Perhaps they buy you a company Ferrari (as you’re the VP of Sales and you drive a lot).
Perhaps they hold management retreats in expensive resorts where family members are welcome.
Perhaps they provide membership in exclusive country clubs.
Perhaps they put half the money aside so they can continue to pay you well even after you no longer work for them (this is called “deferred compensation”).
Is this legal?
Now, in general, this is the point at which people ask “Are those types of business expenses allowed”?\
That question needs to be answered with “Allowed by who”?
Congress determines our laws. Congress determines our tax laws. Congress determines what is and is not legal.
These tactics have been done in the past. In the past, some of these deductions (business entertainment for example) were more generous than they are now, but Congress made that change. Congress can make whatever change they agree on and pass into law.
So, are these types of business deductions legal? When Congress says they are, they are.
Many people initially have trouble grasping this idea
Below is a video of an exchange that took place at the 2019 Davos meetings.
Michael Dell is asked if he supports a 70% income tax rate on incomes over $10M, and even he, as smart as he is, answers the question in such a way as to indicate he believes high marginal tax rates are about tax collections.