My frequent links to Felix are evidence of my esteem for him. But I have to register a slight disagreement with him with regards to his recent post on marginal tax rates. Felix describes David Kocieniewski’s story in yesterday’s New York Times on whether upper-middle-income households should face the same marginal rates as those earning millions of dollars in annual income:
The fact that families making $250,000 are sometimes being invoked in the same terms as billionaires is a symptom of one of the paradoxes of the American tax system: at the same time that wealth has become far more concentrated in recent decades, the tax code has become far less precise in differentiating levels of affluence.
Today’s tax code not only has far lower rates than it had a half century ago, it has fewer brackets — just six. Mr. Obama’s plan would raise the top bracket (which affects income for individual filers who earn over $382,550) to 39.6 percent, from 35 percent. It would also raise the second-highest bracket to 36 percent, from 33 percent.
Mr. Obama’s plan would charge the same rate on the 382,551st dollar of earnings as it would on the 30 millionth.
In Felix’s view, Kocieniewski is reinforcing a basic confusion. Households earning over $250,000 aren’t facing the same average tax burden as millionaires and billionaires. Rather, they are paying higher taxes on their 250,001st dollar of income and all dollars above that. At the same time, they benefit from the cuts on taxes on dollars below that threshold. The average tax burden of most HENRYs will thus go down. Felix writes:
So when the NYT’s David Kocieniewski starts talking about “many families with income levels near the $250,000 cutoff”, he’s making a serious error. If you’re anywhere near that cutoff, your tax bill is set to go down, even as the tax bills for those millionaires and billionaires are set to go up.
The clear implication of Kocieniewski’s article is that the rich middle classes — “a couple in Westchester County, a police officer with a lot of overtime and a principal at a public school”, say — are going to suffer the same tax hike as millionaires and billionaires. And that simply isn’t true, even if they’re making significantly more than $250,000 between them.
I actually don’t think that’s entirely fair to Kocieniewski, who is invoking the resentment, if I may, of HENRYs rather than denying that marginal tax rates are what’s at stake.
But I’ll say this: the clear implication of Felix’s post is that the rich middle classes aren’t going to suffer all that much if their effective marginal tax rate goes up considerably. And that may be true in a sense — more leisure never killed anyone — but the disincentive effects of the marginal tax increase are as big as they would be if the increase applied to all income. So we don’t get as much revenue as we would if the average tax burden increased, but we get as big a decrease in work effort as we would if the average tax burden increased. That is what those of us who oppose marginal tax increases for high-earners are worried about. This is also true of marginal tax increases that only apply to millionaires or billionaires.
The tax cuts that HENRYs will receive will, as Felix notes, reduce their average tax burden. But they will do nothing to improve work incentives. They are essentially a transfer from future generations to today’s HENRYs. I have to say, that doesn’t make much sense to me.