In January, freshman Representative Alexandria Ocasio-Cortez (D-NY) proposed increasing the top marginal income taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. rate on income exceeding $10 million to 70 percent to fund a “Green New Deal.” Supporters have called this top rate “a return to the 20th century norm,” when the top rate went as high as 92 percent.
Comparing top marginal income tax rates across time is not an apples-to-apples comparison. Years ago, there were more tax preferences available to wealthy taxpayers to lower their effective tax rates.
After Rep. Ocasio-Cortez released her plan, Joe Nocera of Bloomberg detailed numerous ways Hollywood entertainers—the wealthiest group of taxpayers mid-20th century—lowered their taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. , in “The Golden Age of Hollywood Tax Avoidance.”
This piece describes the lengths went by entertainers—such as Bob Hope, Bing Crosby, and Frank Sinatra—to avoid the era’s high marginal income tax rates. From an oil depletion allowance that reduced taxable income related to oil drilling by 27.5 percent, to “collapsible corporations” that absorbed income and allowed it to be taxed under lower corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. rates, Nocera discusses a range of tax preferences entertainers used to lower their tax liability.
Nocera summed things up like this:
It is true that the U.S. economy did extremely well during the two decades when the marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. was 90 percent or above. But it’s not right to say the high tax rates didn’t have an impact on economic behavior. They certainly did….I’m not saying we couldn’t do with more taxes on the rich. But let’s be careful. When Bing Crosby won’t give a concert, it’s safe to say that the marginal tax rate is too high.
This article is as entertaining as the performers it covers, and it is worth reading. It demonstrates, anecdotally and with great detail, the energy Hollywood put in to avoiding Uncle Sam’s high income tax rates.
This type of avoidance is costly for society. As economists Jason Fichtner and Jacob Feldman point out:
Tax Avoidance occurs when individuals or businesses reallocate consumption and savings patterns in order to minimize tax burdens. These behavioral responses to tax avoidance result in what economists call decreased allocative efficiency—a loss of economic transactions that would increase standards of living: the vacation not taken, the food not purchased, the smaller wedding gift acquired, and so on. In other words, consumers make smaller spending and saving decisions than they would otherwise.
In recent decades, the individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. ’s base has been broadened and the top marginal rate has been reduced, reducing both the incentive for taxpayers to avoid income taxation and the tax preferences available for them to do so.
This has reduced the gap between the top individual income tax rate and the effective tax rates of the top 1 percent. In 2016, the top marginal income tax rate was 39.6 percent, while the top 1 percent of income taxpayers paid an effective income tax rate of 26.9 percent. In the 1950s, when the top marginal rate exceeded 90 percent, the top 1 percent’s effective tax rate was as low as 16.9 percent.
When thinking about increasing marginal tax rates, policymakers should consider that taxpayers will respond to these marginal increases possibly through tax avoidance, which is costly to society. On the other hand, decreasing marginal tax rates while eliminating tax preferences can increase effective tax rates. As the Bloomberg article shows, current policy discussions would benefit from a historical perspective.
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