Last Monday, Aaron Edlin and I published a cri de coeur op-ed in the New York Times calling for a Brandeis tax, an automatic tax that would put the brakes on income inequality. This is the third in a series of posts (the first and second posts are here and here) explaining more about our rationale and providing more details on how a Brandeis tax might be implemented. You can also listen to my hour-long interview on Connecticut Public Radio’s “Where we Live” here.
Of Lags and Caps: More Details About Possible Implementations of a Brandeis Tax
By Ian Ayres & Aaron Edlin
Remarkably of the hundreds of emails we received in reaction to our op-ed, almost no one questioned Brandeis’s idea that we can have great concentrations of wealth, or democracy but not both. People questioned other aspects of our proposal, asking questions like (1) how would it work in a world of income bunching; (2) would people still have the incentive to work hard; and (2) is it fair to have very high tax rates on the affluent.
Our last post talked about alternative potential triggers. Here we tackle some more detailed questions about implementation including how to trade off different kinds of distortions.
A Lagged Moving Average
Several commentators raised questions about the timing. In our op-ed, we proposed that the IRS would announce in the midst of a tax year what the rate for one-percenters would be based on the Brandeis ratio of the past year. On reflection, this implementation unnecessarily fails to give taxpayers adequate notice. It would be unfair to only give a taxpayer notice on September that her marginal rate had increased. A simple answer would be to have the one-percenter rate to be based on a moving-average of the last five-years of Brandeis ratios, and to have the IRS announce the one-percenter rate before the tax year begins. So, for example, during the fall of 2020, the IRS would calculate the Brandeis surtax needed to keep the after tax Brandeis ratio in line for 2019 and average that information with the surtax for 2015-2018, to promulgate a rate that will apply to one-percenters in 2021. The system would include averaging in zeros for years in which the Brandeis ratio failed to trigger. Using a lagged-moving average gives taxpayers better and less volatile information on what their tax rate will be. It means that the attempts to lean against inequality will be lagged – perpetually a step behind – but such a system would still take action against increases in inequality. It would put the brakes on inequality rather than stopping it in its tracks.
Another modification worth considering for a Brandeis tax would be a reinvigorated system of income averaging. The 1% club is not fixed. Until 1986, tax payers who earned a lot in one year could average their income over three years. Now only fishermen and farmers and a few others can do that. Without income averaging, taxpayers with “bunched” income might really take a beating. An entrepreneur who cashes out when the market is right might have the same lifetime income as an attorney, but might find herself paying a much higher Brandeis tax because so much of her life-time income is realized in the cash-out year. Her profile is 97th percentile for 20 years and 99.5 for one year, while the attorney is 98th percentile for every year. Under reinvigorated income averaging, taxpayers who normally fall below the one-percent cutoff would avoid the Brandeis tax by averaging their unusually high payday over ten years. So we’d support averaging on both the tax-payer side and on the tax-trigger side of the equation.
Incentives to work
Some economists like Martin Feldstein always find that higher taxes lead people to work less. Others disagree. Very few, if any, of these studies are however on the top 1% (or the top one-tenth of the one percent).1
Do people in the top 1% ask themselves whether the $1000 or the $5000 that they make from an extra hour of work will buy them goods worth the work’s effort, as economists tend to model the matter? Or do these people work hard for intrinsic rewards? Or do they mainly glean satisfaction from earning more than others earn?
The first question inspired Ronald Reagan to lower the top tax rates. He remembered a day back when he was a lad when he didn’t make that extra movie because tax rates were 90 percent. To economists that represents a tragedy of inefficiency. To movie fanatics, who have seen enough of his B rated flicks, it may have been a mercy.
But we doubt there is all that much reason to think Ronald Reagan’s reaction was either typical or tragic. Our Cornell colleague Robert Frank has argued that rich people are largely motivated by status goods, and by relative status. If so, they can be just as happy with less money so long as other rich folk have less money too. If that is true, then taxing the rich is a free lunch. Surely the government, even a wasteful government can use the money for something. (Hint: reduce the long run fiscal deficit.)
High tax rates are also not a worry if rich people are motivated by intrinsic rewards. (Perhaps that applies more to real artists who must do art than to Ronald Reagan.)
More worrisome is the possibility that the rich would flee the U.S. if tax rates climbed too high. This is possible, and would not be good.
In any event, we are not terrified about any of these possibilities. The Brandeis tax is not dramatic. In fact, it would not kick in at all unless inequality rose. And even if the pretax Brandeis ratio rose to 50, we might only need 40 or 50% marginal rates at the top, depending upon what the median income earner pays in taxes.
And, if necessary to get passage, we would be happy to live with a cap on the Brandeis tax. Because of concerns with work incentives or with moving income abroad, we might cap the maximum Brandeis tax at 50 or 70 percent. Our larger point is not to deny the possibility that higher marginal rates can produce economic distortions. But these possible distortions need to be traded off against the democratic distortions of living in a country with vast disparities in economic power.
In 2010, Greg Mankiw wrote in the New York Times that Obama’s proposed tax-increase on incomes greater than $250,000 would make him work less.
First, I have to acknowledge that the Democrats are right about one thing: I can afford to pay more in taxes. My income is not in the same league as superstar actors and hedge fund managers, but I have been very lucky nonetheless. Unlike many other Americans, I don’t have trouble making ends meet.
Indeed, I could go so far as to say I am almost completely sated. One reason is that I don’t aspire for much more than a typical upper-middle-class lifestyle. I don’t fly around on a private jet. I have little desire to own a yacht or a Ferrari. I own only one home, in which I have lived since 1987. Paying an extra few percent in taxes wouldn’t create a lot of hardship.
Nonetheless, as Republicans emphasize, taxes influence the decisions I make. I am regularly offered opportunities to earn extra money. It could be by talking to a business group, consulting on a legal case, giving a guest lecture, teaching summer school or writing an article. I turn down most, but accept a few.
And I acknowledge that my motives in taking on extra work are partly mercenary. I don’t want to move to a bigger house or buy that Ferrari, but I hope to put some money aside for my three children. They will never lead lives of leisure, but I hope they won’t have to struggle to find down payments to buy their own homes or to send their kids to college.
Greg went on to conclude that increased taxes would reduce his marginal incentive to save for his kids. But especially for one-percenters, like Greg, who care about their kids, we think they should also be asking whether they want their kids to be growing up in a world where the Brandeis ratio might escalate to heretofore unknown heights. An irony, not lost on Greg, is that higher tax rates might actually lead him to be a better father. As he wrote on his blog:
[If the Obama tax is passed,] I expect to spend more time playing with my kids. They will be poorer when they grow up, but perhaps they will have a few more happy memories.
Distinguishing Among the One-Percenters
Some commentators have pointed out that it would be inequitable for the merely rich – those barely in the 1% club with taxable incomes just above $330,000 per year – to face the same marginal Brandeis tax as the ultra rich. Why should small business owners face the same inequality tax as those with taxable incomes of tens or even hundreds of millions of dollars per year? This is a reasonable question, but it is hardly a devastating criticism of our central proposal for inequality-contingent taxation. It would be possible to structure an automated Brandeis tax that allowed for a progressivity within the 1% club. For example, the maximum marginal-tax add-on might be a function of the number of medians for particular taxpayers. If your taxable income is 10 times greater than the median household income, your Brandeis tax might be capped at 10% above the normal rate, whereas if your taxable income is, say 36 medians, you might be subject during periods of increasing inequality to a surcharge of 36%.
Fairness of high taxes on the affluent.
One of our more right wing colleagues thinks taxes amount to theft (beyond what is needed for police) and higher taxes on the rich are particularly irksome. We find this a little bewildering. It starts with a philosophical premise that we earn what we receive. The labor theory of value may make a sense if we farm land that has been in our family for generations. But in a modern economy it is puzzling. The validity of “earning what we receive” is particularly tenuous amongst the many CEOs who constitute the 1% – as our colleagues Lucien Bebchuk and Jesse Fried describe in their book entitled “Pay Without Performance: The Unfulfilled Promise of Executive Compensation,” flawed management and poor oversight often contribute more to executive salaries than actual value-added.
Could Bill Gates or even Ayres or Edlin earn their living without the state to protect our persons, to enforce or contracts, to invent the internet (we don’t mean Al Gore), or to do any number of things? Not the livings we enjoy. John Rawls, one of the 20th centuries great philosophers, would say that most of what we earn is a surplus that we owe to society, for without society we could not earn it. If the top one-percenters cannot claim to have been fully self-sufficient in their income, in what sense have they earned it, and why is it wrong for the state to take even a large share?
Our take is that it may be either wise or unwise for the state to tax 50, 60, or 70 percent of income. But it is not theft. It is not a priori wrong. Elizabeth Warren got it right earlier this fall when she said “there is nobody in this country who got rich on his own.”
1A Gruber and Saez study finds:
the overall elasticity of taxable income with respect to changes in net-of-tax marginal rates is 0.4. That is, a 10 percent change in the marginal net-of-tax rate (that is, the difference between 100 percent and the marginal tax rate) leads to a 4 percent change in taxable income. Gruber and Saez demonstrate that this elasticity is primarily the result of a greater response by taxpayers with high incomes. *** They show that taxpayers with incomes above $100,000 per year (in 1992 dollars) have an elasticity of 0.57, much higher than the 0.4 result for the whole sample. *** These results are based on a study of the NBER’s panel of tax returns over the 1979-90 period.
But the study is largely based on pre-gilded age era and do not estimate the elasticity for people with taxable incomes of 36 medians.
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Incentive to Work? I don’t understand why this is not challenged more. We are not talking cleaning toilets here – if the 1% can’t be bothered to do more work, the 2% would be glad to step in, thus helping to achieve the income equality goal. For all the jobs being turned down – starring in B movie, talking to a business group, consulting on a legal case, giving a guest lecture, teaching summer school or writing an article – I am sure all these jobs eventually got done by someone almost as talented, so the economic loss would be quite small.
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I am intrigued by this proposed tax, however I question a couple of specific assumptions:
1) You assume that it is fine for the government to waste money taken from the excess an individual makes, while hinting that it could be used to reduce the current debt load. I think it would be highly unlikely for the government to suddenly run out of things to fund and, finding a little extra cash on hand, pay down some extra debt. The proposed purpose of this tax seems to be the reduction of certain individuals income, not the funding of particular endeavors. Higher taxes on the rich may not be a priori wrong, but it is morally suspect to have the proposed end of this tax as just a new creative way to reduce the incomes of those who make more than they need.
2) You assume that the government is the best representation of society. John Rawls is right that we would not have much of what we have without the society in which we live. However to conclude that we ought to give more to the government in response is false. There are many ways to contribute to society, funding of government programs is in no way the primary way to do that.
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Paul, it sounds like you might not be opposed to this if taxpayers had the option of paying a non-profit, rather than giving it to the government. Would you favor a Brandeis Tax if you could opt out with an equivalent donation to a tax-deductible non-profit? This seems like a reasonable modification of the proposal to me.
I would like that better than what was initially proposed, but again, it would continue to have its end as the reduction of income of the rich. I still think it would be outside the limits of what the government should have the power to do.
Paul in response to your points:
1) Nobody assumes it’s okay to waste any tax money (although most would agree some waste is inevitable and too much goes on just now).
2) To argue against a metod of taxation on the grounds that it will only lead to more government psending seems silly to me. We need to raise a certain amount of tax from somewhere. Surely to have an informed debate about tax and spending you need to be able to seperate who pays from what we’re spending on?
2) There’s enough evidence to make a reasonable argument that income inequality is in itself a bad thing in that it has bad social consequences. (I expect it probabaly is, you probabably expect it’s not). If it is, it’s not at all morally suspect to have a tax with the sole purpose of reducing inequality. So I’d suggest you focus on arguing that income inequality never hurt no one. Having said that, I see no reason why tax money raised from a brandeis tax would be spent any better or worse than other taxes, or would lead to more government spending. I’d reiterate the importance of the seperation of who pays and what we buy.
3) Why does this assume government is the best representation of society? It doesn’t even assume that government collects more tax in total. Just that if the rich’s income rises quiker than everyone else’s they get taxed more. That could be used to offset tax cuts for the poor or pay off debt. Again, the seperation thing I was banging on about.
I agree with you. “The poor don’t make as much as the rich. We’re going to solve that problem by taking money from the rich”. That doesn’t do much to help the poor. And while the 1% may be driven by something more than money…the knowledge that I could suddenly be subjected to a 50% or 70% income tax would definitely give me second thoughts about starting my own business versus continuing to be an employee.
If you started your own business, chances are you’d make nowhere close to what you have to make to pay 50% in taxes (over $1 million). And even if you did, making a net $500,000 a year without having to pay for healthcare or worry about your kids’ college tuition sounds pretty damn good to me.
I assure you would barely feel even a 70% tax if you made what the average CEO gets , $11.4 million.
Taking more money from the rich so long as it doesn’t result in the rich downing tools does a lot to help the poor.
It means that either the poor get taxed less or that they get better public services. It also means that they get a larger proportion of the economies total output. So as long as the taxing the rich doesn’t cause them to down tools, the poor get more. And it’s clear that you can take quite a bit from the rich before they down tools.
Would some people choosing to work less cause an economic loss or allow for other workers to take that work on? Would this be a second benefit where the government doesn’t have to redistribute wealth but instead would alter the incentives for people who’ve “have enough” to allow other citizens to earn more?
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This post completely dismisses any of the legitimate moral and economic criticisms of the Brandeis Tax without refuting them, they are simply dismissed. It is not a priori wrong, what moral justification do you use to come to that? Do rich people work less when taxed more? Well I have this study that says so, but I am going to flippantly ignore it because people have evolved substantially in 100 years. What? Do you know nothing about biology?
Hot debate. What do you think?
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I am sickened by this article. It is the nightmare of Atlas Shrugged come to pass. By even starting the conversation of accelerating the already criminal progressive tax structure in this country, we set a philospohical baseline for a debate that should be about fairness and equity. Why should success and effort and talent be punished by the theft of one’s compensation by the govenrment. This article parses the basic morality by semantically tiptoing through the arguments: “at least Ronald Reagan didn’t make another B movie”.
The tipping point of a democratic society’s demise is when 51 percent of the people derive more benefit from the government raising taxes than they do from the government lowering taxes. The US is shooting past that like a rocket.
The demonization of the people who create wealth — and pay for the lower classes’ safety net — is something that should be discouraged by society’s adults who aren’t in tents in the nation’s parks this year protesting nothing. The authors here are gleefully dreaming up scenarios of how to get at Other People’s Money like bank robbers dreaming how to spend their loot.
Who is John Galt? Man up and get in the Top One Percent, don’t plot ways to steal from them.
The fallacy of large numbers does not make the following less true:
“Let not him who is houseless pull down the house of another, but let him work diligently and build one for himself, thus by example assuring that his own shall be safe from violence when built.” — Abraham Lincoln
Hot debate. What do you think?
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Postscript to the Lincoln quote: And I believe it is fair to reasonably equate taxation to violence. If you don’t pay property taxes, your home is seized — torn down as far as you are concerned. If you don’t pay income taxes, you are imprisoned. The government wields the same power of theft Lincoln is addressing.
Hot debate. What do you think?
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Hey now, this is Freakonomics – we don’t take kindly to morality in here.
You say it’s repugnant, I say… Let’s do it!
“Who is John Galt?”
A invented character from a work of FICTION. Open your eyes.
Better yet, get your walled fortress ready; you’re going to need one.
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“the people who create wealth – and pay for the lower classes’ safety net”
Last time I checked, a large portion of our safety net is being financed by future generations through deficit spending. Another large portion is financed by working classes on the margins.
The main points of this debate are:
- The safety net is no longer funded sufficiently by the taxes we have.
- Wealth-creation is still happening, but it has become confined to those who already have it. The middle and lower classes are not seeing real increases in wealth, even during expansion times.
The true enemy of free markets are the so-called “capitalists” who are actually monopolists seeking to undermine the market system, using political and social advantages to subvert the forces of supply and demand.
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Wow, Paul, you just said exactly what I said in response to another post. That is the key. Why are we giving so much attention to the rich (to punish them) instead of focusing on the poor?
Now, on the giving back to society thing, that is a valid point. But society is not one unit. Society is a collection of individuals. So every time I do something that benefits another individual, I am giving to society. That means every time I spend money, I am helping other members of society to have jobs and get paid. I bought a TV a month ago. That money went, indirectly, to several employers, who then used it to pay their employees. LG and Best Buy are two obvious ones, but distributors, makers of other parts, etc., all benefitted as well. I tithe at church — this money supports many ministries that make a big difference to society. When I buy food, I am helping the workers at Aldi to have jobs.
Taxation is not the most efficient way to benefit society. Investing provides benefits to the companies that are invested in, who are able to employ people as a result of having this working capital. The only way any money earned does not go back to benefit society is if it is stuffed in a mattress. And not many people use that particular savings method.
It strikes me that the term equality is being hijacked. 50 years ago, there was a lot of talk about equal opportunity. This is the idea our society has thrived on — any person should have the opportunity to excel and achieve.
But income equality is actually the opposite. Because when we regulate the outcome (i.e. the income), we are working against the opportunity.
If a government guarantees one, they automatically limit the other. Because people are unique, different people are differently motivated. And the great thing about our country as it was founded is that they did dream of freedom — and this is only possible if we have equal opportunity. Of course, there were some problems, particularly slavery, at this time, but thankfully that got fixed.
But equality of outcome negates equality of opportunity. The Chinese talk about yin and yang. Balance. If you have the freedom to succeed, you also have the freedom to fail. This is what equal opportunity is. If you are unable to fail, then you do not truly have opportunity to succeed, because everything is dictated. Therefore, engineering outcomes squashes liberty. Opportunity, from day one, is what freedom truly is.
This is why many of us oppose socialistic policies — they attempt to engineer outcomes, and every engineered outcome erodes opportunity. It may sound utopian, but the human spirit is crushed when its freedom is removed.
Income equality is a form of equality, but it is not a goal to move toward at the expense of liberty. Rather, we should be spending our time and energy working on helping those who are poor, so that they can take full advantage of opportunity, while not impeding upon the opportunities of the rich.
When the government determines the outcome before we even even begin, we remove motivation — changing of outcomes is what motivates successful people, whether it be their own outcomes or those of others. When this freedom is gone, so is progress. We become little more than robots who cannot function without government to tell us what to do. Orwell showed an extreme example of this. But it is very possible. It won’t happen in our lifetime, I don’t think. But every step we take in that direction makes it harder to go back and change course down the road.
Hot debate. What do you think?
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“Opportunity, from day one, is what freedom truly is.”
I would tend to believe that opportunity is what “liberty” truly is; I think there are succinct differences between “freedom” and “liberty.”
Not to drag up ancient history, but the founding of America was never about freedom; it was about liberty.
Sorry for interjecting; otherwise a great post.
Very interesting.
One of the things I keep hearing is that if you tax the very rich, they won’t use the money to create jobs. Apparently, they are not being taxed, yet they still do not seem to be using the money to create jobs.
The government may be very wasteful, from the Federal level all the way down to the local level, but they are also the only ones who build and maintain many major infrastructures, most notably our roads, bridges, etc.
It seems to me that if private sector are not creating jobs with their money in economics times such as now, it falls to the government to do so. Even ignoring areas like education and social services, many municipalities are laying off, or not replacing, police officers and fire fighters. Our local streets have pot holes, some are in desperate need of resurfacing and line painting, and our parks, state and local, are going without maintenance (and illicit marijuana growers are supposedly utilizing acres of our state parks, woe unto the unfortunate hiker who stumbles across such an encampment and gets shot).
If you’re really rich, perhaps going to a national, state or local park is not on your list of fun things to do, but it is part of the infrastructure (loosely, possibly), and if the people on whose backs they make all their money are not safe because there isn’t enough money for our society and governments to protect them, then eventually, there will be no workers to make the very rich able to stay very rich, much less become any richer.
I agree, if a Gates, or a Buffet, or any other person in the 1% are highly taxed, it is unfair. But if they are all highly taxed (in a reasonable fashion, as seems to be the argument in this article), they are still outrageously wealthy (at least to me
, and not only do not lose all that much, relative to each other, but potentially gain more in the near future as their loss in taxes shores up, and hopefully expands, the infrastructures upon which they build their wealth generation.
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Let me ask everyone a question here.
Would you honestly even contemplate starting a company right now in America that actually made something? Do you have any idea how much paperwork and regulations and taxes and risk you have to take?
To create jobs? Can you see the roadblocks we have put up in the last half century to being your own boss, the American Dream? Has it really been watered down to 40 years of servitude and an IRA?
Forget about the One Percent. They are just the low hanging fruit to get in the door. Soon it will be the Five Percenters. Then the Ten Percenters. They are easy to vote out — 90-10. Then the Net Worth Over A Million Percenters. Then anyone with a nice car.
First they came for the Communists, but I was not a Communist, so I said nothing.
Then they came for the Social Democrats, but I was not a Social Democrat, so I said nothing.
Then they came the trade unionists, but I was not a trade unionist, so I said nothing.
And then they came for the Jews, but I was not a Jew, so I said nothing.
Then they came for me, and there was no one left to speak for me.
—Martin Niemöller
Hot debate. What do you think?
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“Would you honestly even contemplate starting a company right now in America that actually made something?”
That depends. Would that company sell something that people want to buy? Would I feel that my customer base would have enough money to spend on my product? Would my product be decent enough quality or low enough in price to compete in the marketplace?
Sure I would consider it – if I felt I could turn a profit.
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This might be the most hyperbolic response to a tiny tweak in the progressive tax structure I’ve ever seen.
As for starting a business, the go/no-go decision point for me (assuming I had a product and solid business plan – things I can control – in place) would be the risk and cost in health insurance; something I have virtually zero control over. That’s our real problem; any (good) regulation will effect an entire industry more-or-less equally.
Recognizing that obscene income inequality is bad for democracy (and it most definitely is) does not mean one must then espouse the position that all outcomes must be equal. By an large Americans expect – and WANT – some income inequality, because it DOES act as a motivator. OWS types would by and large prefer a return to pre-Reagan levels of inequality (and a return to pre-Reagan levels of lobbying would be a terrific improvement as well).
“…if the people on whose backs they make all their money are not safe because there isn’t enough money for our society and governments to protect them…”
In reality the government has far more money than it needs to insure a reasonable level of protection for every person in this country. Indeed, some of us would argue that we’re more in need of protection FROM the government in the form of Homeland Security, the DEA, BATF, and more.
The thesis that any one persons income is based on the fact that there is a structural organisation already in place to provide a person a method to create income, and thus the structure is allowed to take what they decide is fair compensation for this structure, simply communism in a more elegant form..
Much like saying the structure of the capitalist system in the US exist because there is a planet called earth with customers all over the planet. Should we then assume all the structural components (Countries) dictate how much money the US can keep and how much we ‘owe’ them for having the structural mechanism in place for us to make money..
What baloney.. Just an elegant way of saying ‘its our money, you can have what we think is appropriate’
Much like my current wife .. What is mine, is mine, what is yours is mine, and I will tell you what part you can have because we have this structural thing called marriage.
What BS..
Hot debate. What do you think?
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