The effects of a 70% top income tax rate

Yesterday, Paul Krugman highlighted an academic paper arguing that if the government wanted to maximize the revenue it collects from the nation's top earners, the optimal top marginal tax rate would be 70%. He notes:

"...if you’re trying to maximize any sort of aggregate welfare measure, it’s clear that a marginal dollar of income makes very little difference to the welfare of the wealthy, as compared with the difference it makes to the welfare of the poor and middle class. So to a first approximation policy should soak the rich for the maximum amount — not out of envy or a desire to punish, but simply to raise as much money as possible for other purposes."

Of course, doubling the current top rate of 35% would bring howls of indignation and anger from those affected. But would it be that unreasonable from a historical perspective? From Roosevelt until Reagan, the top marginal tax rate never dipped below 70% - and throughout the economic boom of the 1950's, the top rate was above 90%(!)

Under Reagan, the top rate was slashed from 70% to less than 30% based on the "supply side" theory that lower taxes would free up the money needed to create more jobs, leading to a stronger GDP, and even more government revenue. So how has employment fared since then?

Click to embiggen. Top marginal tax rate data taken from the Tax Policy Center. Unemployment data taken from the Bureau of Labor Statistics.

Slashing income taxes for the wealthiest did not help the employment situation. On the contract, average unemployment over the 30 years since the massive Reagan tax cuts for the wealthiest earners has been 6.3% - more than a full percentage point higher than the 5.2% average over the 32 years before that.

What about the "supply side" theory that cutting taxes on the rich would increase revenues for the government? Take a look at what has happened to the gross federal debt over that same period.

Click to embiggen. Gross Federal Debt data taken from the White House Office of Management and Budget's Historical Tables Table 7.1: "Federal Debt at the End of Year," then converted to 2005 dollars using Table 10.1: "Gross Domestic Product and Deflators Used in the Historical Tables."

Once again, the "supply side" theory falls apart. From 1948 to 1980, the Gross Federal Debt held steady between $1.8 trillion and $2.5 trillion (in inflation-adjusted 2005 dollars). The Reagan tax cuts immediately caused the debt to start swelling, and it hasn't stopped since then.

For the past decade, there has been a political fight between the Democrats and the Republicans over whether to roll back the Bush tax cuts. This is the wrong fight. The tax cuts that need rolling back are the Reagan tax cuts. It's time to bring back the 70% top marginal income tax rate for the 1%.