As anybody who has followed the health care debate on Capitol Hill knows, Democrats are looking everywhere for money and they appear set to raise taxes on high-income taxpayers. Charlie Rangel recently told the New York Times that the best way to do so is via a surtaxA surtax is an additional tax levied on top of an already existing business or individual tax and can have a flat or progressive rate structure. Surtaxes are typically enacted to fund a specific program or initiative, whereas revenue from broader-based taxes, like the individual income tax, typically cover a multitude of programs and services. that will raise top marginal 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. rates on high-income taxpayers. On the contrary, most mainstream public finance economists would argue that such a policy is one of the worst ways to raise revenue (controlling for differences in distributional viewpoint). Base broadeningBase broadening is the expansion of the amount of economic activity subject to tax, usually by eliminating exemptions, exclusions, deductions, credits, and other preferences. Narrow tax bases are non-neutral, favoring one product or industry over another, and can undermine revenue stability. (e.g. limiting exclusion of employer-provided health insurance) is better than 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. hikes.
Now some argue that any tax hike is bad and thereby suggesting such revenue raisers is akin to supporting tax hikes. But that’s not the issue here. Even if a member of Congress is opposed to any tax hike as a rule of thumb, some tax hikes are worse than others. It’s not just the revenue amount that’s part of the total tax burden; economic efficiency costs (i.e. excess burden) and compliance costs are part of the tax burden as well.
If Congress is seeking another $500 billion in revenue, it’s better to raise that revenue in a way that has a smaller marginal excess burden, all else equal. Changing a bill that raises $500 billion in revenue in a terrible way into one that raises $500 billion in revenue in a less economically harmful way is the equivalent of inserting an amendment that lowers the revenue amount! The total tax burden in the bill has been reduced and after-tax incomes for households will be higher, all else equal.
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