Beware the Seventy Percent Tax Rate

Our gigantic federal deficit is often used as a cudgel to demand tax increases.  Have you ever wondered just how high taxes would have to go, in order to cover that deficit?

Michael Boskin of the Wall Street Journal took the time to figure it out:

To cover the Congressional Budget Office projection of Mr. Obama’s $841 billion deficit in 2016 requires a 31.7% increase in allincome tax rates (and that’s assuming the Social Security income cap is removed). This raises the top rate to 52.2% and brings the total combined marginal tax rate to 68.8%. Government, in short, would take over two-thirds of any incremental earnings.

Boskin goes on to point out that the situation would rapidly deteriorate from there, as Social Security and Medicare become howling black holes of liability, and the Laffer curve drains away the anticipated revenue from tax increases by reducing economic activity.

No big deal, right?  That’s just marginal taxes on the Evil Rich, those heartless “millionaires” who earn over $200,000 per year, isn’t it?  Guess again:

It would be a huge mistake to imagine that the cumulative, cascading burden of many tax rates on the same income will leave the middle class untouched. Take a teacher in California earning $60,000. A current federal rate of 25%, a 9.5% California rate, and 15.3% payroll tax yield a combined income tax rate of 45%. The income tax increases to cover the CBO’s projected federal deficit in 2016 raises that to 52%. Covering future Social Security and Medicare deficits brings the combined marginal tax rate on that middle-income taxpayer to an astounding 71%. That teacher working a summer job would keep just 29% of her wages. At the margin, virtually everyone would be working primarily for the government, reduced to a minority partner in their own labor.

The dreams of the powerful come to ruin through the disobedience of their subjects.  Taxation is compulsion, and naturally generates resistance.  The first level of that resistance – the shallow end of the Laffer curve – comes through the avoidance of taxation, by taking advantage of various exemptions and loopholes. 

The steep dive hits when economic activity becomes illogical, because the government will simply take the proceeds for itself.  What’s the point of putting in a few hours of overtime, when the government will swipe 70% of your earnings?  What growth can we expect when Uncle Sam is the cash-hungry majority stockholder in every venture?  Why bother to work at all, when indolence makes more economic sense than effort?

Mr. Boskin’s work has special significance for me.  Long ago, in my college days, I heard a similar projection of future tax rates and thought, “That’s just not going to work.”  Everything I’ve learned and written about politics and economics proceeded from that moment of awakening.  Seventy percent income tax rates are the mark of a future that will not work.  Literally.