Taxing the Wealthy
IPR policy briefing provides salient data and research
From left: Panelists William Gale of Brookings, Charles Varner of Princeton, and IPR's Monica Prasad discuss "sharing the burden," millionaire tax migration, and the public's views on taxes at a research briefing that took place during congressional negotiations over raising taxes on America's wealthiest households.
The president's signature has barely dried on the January 2 deal that saved the country from going over the fiscal cliff. One of its core compromises involves raising rates on Americans who make more than $400,000 ($450,000 for couples). Negotiating the higher tax rate was one of the biggest sticking points between Republicans and Democrats in the tumultuous negotiations. A recent IPR policy research briefing on Capitol Hill brought together three national experts to cut through some of the verbal sparring on the topic.
The three scholars—IPR sociologist Monica Prasad, who organized the briefing, economist William Gale of the Brookings Institution, and rising scholar Charles Varner—brought their research and public opinion data to bear on questions of fairness in the tax code, millionaire response to higher taxes, and the anti-tax agenda of the past decades for the 40-plus congressional staffers, academics, students, and policy advocates in attendance at the December 7 event.
“The topic is extremely timely,” said IPR Director and event moderator David Figlio. “Some of the research presented, in particular Monica Prasad’s on voters’ reactions to cuts for local services and 2011 debt-ceiling talks, holds important implications for forthcoming talks over the debt ceiling and federal spending cuts due to sequestration.”
One of the nation’s leading fiscal experts and co-director of the Urban-Brookings Tax Policy Center, Gale began by reviewing some of the reasons behind the partisan acrimony during fiscal cliff discussions.
“Economics tells us a lot about how to design a tax system, but it doesn't tell you everything you need to know,” Gale started, pointing to value judgments that open the door for conflict, such as defining the tax burden on current vs. future generations. While economists have yet to define such basic indicators, such as the optimal debt-to-GDP ratio, he noted that such ambiguity is no excuse to shy away from a tax system that balances equity with efficiency.
Current tax revenues are at a 60-year low, and even if they recover to pre-recession levels of 18 or 19 percent of GDP, Gale advised that more is needed. Otherwise, it will be impossible to finance the increased numbers of retirees, defense and healthcare costs, and interest payments. That is why long-term tax increases should be part of any solution, he emphasized.
Just holding down tax revenues, or “starving the beast,” will not curtail spending. “The evidence of the last 30 years supports that,” Gale added.
The only way to achieve “shared sacrifice”—where all members of society share in bearing the costs of the deficit—is to include higher taxes on high-income households in the deal, Gale said.
He underscored that the debate over raising the top tax rates is blown out of proportion. The current top tax rate of 35 percent is lower than in the past, with some proposals aiming to raise it to 39.6 percent, which was the rate eventually agreed upon in the compromise. Even when top earners’ rates were around two times higher, like 70 to 85 percent in the 1950s and 1960s, “the economy did just fine,” he observed.
Gale also suggested targeting top tax expenditures, as they disproportionately benefit the top 5 percent of U.S. households. Attacking the top five tax expenditures (healthcare, mortgages, 401(k) plans, accelerated depreciation, and capital gains) could raise “significant amounts of income”—though Gale acknowledged that their popularity makes such changes politically difficult.
Another major argument against raising taxes on the wealthy is that it will disproportionately affect small business owners. Yet new Treasury data show that while 70 percent of those making more than $1 million have some sort small business income (50 percent for those making between $200,000 and $1 million), this income only accounts for 6 percent of their total adjusted gross income. Cutting the top tax rate still leaves 94 percent of their income untouched, Gale said.
“Raising revenues is not a crazy idea, and raising revenues from high-income households is not a crazy idea,” Gale ended. “You can do that in a way that improves the economic system, reduces inefficiencies, and improves intergenerational equity.”
One of the biggest arguments legislators have made for keeping tax rates low on the wealthy is that they will pick up and move to lower tax jurisdictions if their taxes are hiked.
With his colleague Cristobal Young of Stanford, Princeton’s Varner tested this idea by looking at what happened when states implemented new taxes on millionaires. Eight states have implemented higher taxes on the wealthy since 2004. This trend stands in marked contrast to most states where income tax rates remain similar for both high- and middle-income earners, Varner noted.
Past research has studied whether people move when jurisdictions in the same geographic region have tax rate differences of between 4 and 5 percent. But few people move to take advantage of lower tax rates, Varner continued.
“It’s very costly to move,” Varner said. Moving involves selling a house or finding a new rental, not to mention the social costs of moving, like leaving behind friends and social networks, which are also the lifeblood of businesses.
But “are the wealthy different?” Varner asked. Greater resources might allow the wealthy to absorb some of the costs of moving more easily. For example, selling one’s home might not even be necessary.
In investigating two of the states to pass “millionaire taxes” recently, New Jersey and California, Varner and Young found answers. In 2005, California passed a new tax that added an additional 1 percent to the top rate for those making more than $1 million per year. In examining all tax returns filed in California over 20 years, Varner and Young could determine each household’s total income and whether a move had been made.
The higher rate meant someone earning $10 million paid an additional $90,000 per year, with those earning multimillion-dollar incomes bearing the lion’s share of the tax change. You would expect to see these people moving, Varner said. But that did not happen.
California is a big state, making it harder for people to relocate cross-border to lower-tax jurisdictions. So Varner also talked about their research on New Jersey, which in 2004 increased taxes by 2.6 percent on those earning more than $500,000.
“In New Jersey, you have this unique situation where if you live near New York City, you can move 20 miles up the road to Fairfield County, Conn., and keep your same job, keep your same house and same network, and just pay a lower tax rate,” Varner explained. “So you expect to see some response.”
Yet in comparing the migration rates of top earners before and after the New Jersey tax came into effect, Young and Varner found no difference between those subject to the tax and other high-income households who earned just below $500,000 (and thus were not subject to the tax).
“In conclusion, there is little evidence for migration response, and millionaire taxes have actually been effective in bridging budget gaps,” Varner said. “It seems like the wealthy depend significantly on economies of place just like the rest of the population.”
Prasad focused on the political consequences of raising taxes on the wealthy, or what she likes to call, “Grover’s Revenge.”
President of Americans for Tax Reform, Norquist created the “no-new-taxes pledge” that more than 1,100 elected representatives have signed, including 258 members of the incoming 113th Congress. The pledge embodies the threat that voters punish politicians who raise taxes at the polls, Prasad said.
In a recent study of tax cuts by the Republican Party starting with the Reagan tax cuts of 1981, Prasad found that Republicans discovered that tax cuts could appeal to working class voters, as long as one adheres to a simple secret—avoiding specifics.
A July 2012 CBS/New York Times poll asked generally whether one would want to see local government services reduced to pay less taxes, with about half of respondents saying yes. But when asked about specific services such as schools, police, and fire departments, between 70 and 80 percent of the same respondents said they did not want to see those local services cut.
In the last two years, Prasad underscored the major changes that have occurred: Voters are now more in favor of taxes on the wealthy, and survey questions have changed. Starting in 2009, some pollsters began uncoupling specific questions on taxing the wealthy from general questions on tax increases.
Reading polls before then, such as those on the Bush tax cuts of 2001 and 2003, one might be led to think that voters do favor tax cuts for the wealthy. However, Prasad’s research signaled something else. She summed up what working class voters said: “We may not like tax cuts for the wealthy, but we certainly do like the tax cuts that show up in our paychecks.”
Delving further into the question, Prasad looked at 55 nationwide polls with sample sizes of at least 800 that did include a question on taxing the wealthy. The aggregate data shows that general support for taxing the wealthy has increased from just over 50 percent in late 2010, hovering in the 60s ever since. A high of 70 percent was hit during the acrimonious negotiations over the U.S. debt ceiling in summer 2011.
Nonetheless before declaring the end of widespread anti-tax sentiment, Prasad emphasized that it was important to consider Republican support for taxing the wealthy. In nine polls that identify respondents by party, she found support among Republicans barely cleared 50 percent with no rising trend—as opposed to the 60-plus percent in polls without this identification.
The political lessons are fairly straightforward, Prasad explained. Voters will not punish Democrats for raising taxes on the wealthy, but Republicans will feel pressure either way, from Republican voters in the primaries or all voters in a general election.
In examining this most recent fiscal crisis, Prasad saw a “recipe for gridlock” in the Democratic strategy to brand the Republican Party as the party of tax cuts that protects privileges for the wealthy.
She suggested that by moving away from this, Democrats would not only help Republicans maneuver out of such a difficult “trap,” but they might also help the country avoid fiscal crisis in the process.
Obtaining Republican support for tax hikes is possible, she continued, as long as one focuses on the tradeoff—what tax increases for the wealthy will buy in terms of specific government programs.
“If they want to do it, this is really the only way to do it,” Prasad concluded.
View a video of Monica Prasad's presentation here.
Please email email@example.com to request a copy of Prasad's presentation.
Policy briefing participants listen and take notes as the speakers discuss equitable and efficient tax reforms, how the wealthy respond to a tax hike, and bipartisan agreement in an anti-tax era.
Photos: Leslie Kossoff/LK Photos
Prasad, M. The Politics of Free Markets (University of Chicago Press, 2006)
Prasad, M. The Land of Too Much (Harvard University Press, 2012)