A Guest Post from John Galt

David Leonhardt writes:

There is no question that the wealthy pay a higher overall tax rate than any other group. That is an American tradition. But there is also no question that their tax rates have fallen more than any other group’s over the last three decades. The only reason they are paying more taxes than in the past is that their pretax incomes have risen so rapidly — which hardly seems a great rationale for a further tax cut.

Really? What if the increase in their pretax income is in part attributable to the tax cuts? David seems to be treating pretax income as exogenous to tax policy, whereas there is good reason, both theoretical and empirical, to think that it responds to policy.

So I started wondering: How much of the increase of the the reported incomes of the superrich might be attributable to cuts in their marginal tax rates?  Let's do some very rough calculations to illustrate the possible magnitude of this phenomenon.  I will start my analysis before the first in the series of major tax reductions, which was the famous Kennedy tax cuts.

Over the past half century, the top marginal tax rate has fallen from 91 percent in the 1950s and early 1960s to 35 percent today.  Thus, the amount a person gets to keep at the margin has risen from 9 percent to 65 percent, that is, by a factor of 7.2.  If the elasticity of taxable income with respect to 1-t is one, as some studies find for high-income taxpayers, then the incomes of the rich would have risen by a factor of 7.2 as well.  If the elasticity is one-half, then their incomes would have risen by a factor of 2.7.  In either case, the change in pretax income attributable to the tax cuts is substantial.

By comparison, the incomes of the superrich (top 0.01 percent), as a share of total income, increased by a factor of about 5 over this period.  So, it seems that for plausible elasticities, a significant portion of that increase can potentially be explained by the cuts in the top marginal tax rate.

To be clear, I am not suggesting that we are now on the wrong side of the Laffer curve and that cutting taxes will increase revenue.  And I will be the first to admit that we don't really know the relevant elasticity for the upper tail of the income distribution.  But I am suggesting that it is a mistake to presume that changes in marginal tax rates have little effect on reported pretax incomes.