After constructing an authoritative database on income shares covering many years and numerous countries, economist Emmanuel Saez, Thomas Piketty, and colleagues have been using these data to plumb important insights on the relationships between growth, policy measures (e.g., taxes, unemployment insurance), and inequality.
This paper examines the relationship between income shares at the top of the scale—the richest 1%–and different tax regimes. The paper asks and answers two important questions: 1) do lower marginal tax rates on the rich result in higher income inequality, and 2) do higher taxes on the rich result in lower economic growth?
Answers: yes and no.
Panel A in the figure below shows a strong negative correlation between reductions in the top marginal rate and the increase in the share of income held by the top 1% of households. Panel B, on the other hand, shows no correlation between such changes and the growth of GDP per capita.
Note that these income shares are pretax, so the correlation in the top panel is not simply induced by the rich keeping more or less of their earnings. You lower tax rates and you just end up with a lot more concentration of the growth in earnings and assets. And what do you get for that in terms of growth for everybody else? According to the bottom panel, nothing.
I’ve long asserted that trickle-down tax policy—cut taxes on the rich and unchain the economic activity that will enrich everyone else—doesn’t lead to faster growth. It just redistributes income upwards. My views on this were strengthened by the very different outcomes in terms of growth, jobs, middle-class incomes, poverty reduction, and our fiscal health during the Clinton vs the GW Bush years. Based on that natural experiment of supply-side trickle down, these findings shouldn’t surprise you at all.
They also complement Paul K’s oped today on why higher taxation on folks at the top of the income scale needs to be part of any plan for getting on a sustainable budget path. Saez et al conclude that the optimal tax rate—the one that would raise the most revenue with the least economic distortions—for the highest bracket is 83%.
Clearly, these guys aren’t running for office. But you get the point. Allowing the Bush highend cuts to sunset takes the top rate from 35% to 39.6%. How about based on these results we nudge that up to 40%, shake hands and call it a day.
Source: Piketty, Saez, and Stancheva, 2011–see link in text.