There is a common narrative in our culture that high marginal tax rates are bad for the economy. Just this morning, in Davos, Switzerland, both Bill Gates and Michael Dell said as such.
This blog post is my attempt to explain why this is NOT true. Why high marginal tax rates are in fact, good for the economy. Why a 70% top margin would be good for the economy.
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, understand that where they say Brackets, I’m saying Rates.
So Why Are Marginal Tax Rates good for the Economy?
This idea was taught me to in an Economics class at a community college in 1983-ish. It was so compelling I remembered it.
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 20 or so years earlier. Almost immediate, someone else chimed in and 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 initially sounds crazy.
High marginal tax rates are not about tax collections. They’re about legal tax avoidance.
For purposes of this example, let’s pretend there are only two tax brackets (the video above uses actually US tax brackets effective 2018).
Our two tax brackets are:
- From $0 to $5M you pay 10%.
- From $5M and up you pay 70%.
Now let’s assume you’re highly paid. Your compensation is $8M per year.
For your first $5M, you keep $4.5M. For your next $3M, you keep $900K. That is a significant loss of value to you for that top $3M due to the 70% tax rate.
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 you to lose that value.
So, they pay you only $5M, and the other $3M is provided to you in various forms that provide value to you but are tax deductible to them.
Perhaps they buy you a company Ferrari (as you’re the VP of Sales and you travel 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 do that for you even after you no longer work for them.
It’s this SPENDING that stimulates the economy.
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. They can make whatever changes they agree on.
So are these types of business deductions legal? When Congress says they are, they are.
Yet Most People Don’t Seem to Grasp 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% marginal 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.