Soaking the Rich Won’t Work

Peter Orzsag, director of the Office of Management and Budget for two years under President Obama, is out with a new paper with a conclusion that is sure to disappoint the increasingly restive Bernie Sanders wing of his former boss’s party: Jacking up the top marginal tax rate barely has any effect on income inequality. Orzsag and two Brookings colleagues, William G. Gale and Melissa S. Kearney, calculated how the U.S. income distribution would change if the top rate increased to 50 percent from 39.6 percent and the new revenue were redistributed to the poorest fifth of households. They found that such a shift would barely make a dent in the Gini coefficient (a standard metric that expresses the level of income inequality as a decimal between zero and one). Orzsag, Gale and Kearney write in their report:

Increasing the top rate to 45 percent would bring in an additional $49.4 billion in revenue. Dividing that evenly among the 36.1 million households in the bottom income quintile (defined over households) would give each of those households an additional $1,370 in post-tax income.

Increasing the top rate to 50 percent with the same redistribution scheme would bring in an additional $95.6 billion in revenue, leading to an additional $2,650 in post-tax income for the bottom fifth of households. Applying a new top rate of 50 percent to income above $1 million for married filers and above $750,000 for single filers would bring in an additional $63.5 billion in revenue, which would result in $1,760 in additional post-tax income for households in the lowest quintile.The reduction in income inequality resulting from each of these tax and redistributive plans is quite modest. The Gini coefficient falls from .574 under the current income tax schedule to .567, .560, and .565 respectively. These are very small reductions in the calculated statistic: .007, .015, and .010, under the three tax increase scenarios.

By way of comparison, when the top marginal rate on earned income was 50 percent in 1979, the Gini coefficient was .435. Thanks to globalization and new technologies—and a whole range of economic and demographic changes that we refer to as the decline of the blue model—the economy delivers much more unequal returns now than it did then, and there may not be a whole lot that the government can do to reverse that shift without enacting truly confiscatory taxes (which, to be fair, is what Bernie Sanders has said he wants to do).

As the authors note, the study itself doesn’t necessarily argue against raising the top income tax rate—one could argue that this is the best way to get new revenue to tackle the deficit, for example, or to alleviate poverty. But if the concern is inequality—the overall gap between the income going to the people at various percentiles of the income distribution—then simply hiking the top tax rate is the wrong way to go. If rising inequality really is really as serious a problem as liberals say it is (and most voters don’t think so) then they need to start offering more innovative solutions than simply soaking the rich.