Marginal rates have now become a topic of discussion, within the Overton Window, thanks to Representative Alexandria Ocasio-Cortez, (D NY-14), who has been saying what I've been saying for a long time, which is that higher marginal rates make for a healthier economy and a wealthier middle class.
One of the infinite things (or so it seems) that I love about @AOC, Representative Ocasio-Cortez, is what she explained when she was interviewed by Ta-Nihisi Coates yesterday at Riverside Church here in New York in a conversation for MLK Now. You can read about it here, and watch the interview in its entirety here. And that is, because she has no political ambition, and takes no corporate or PAC money, she is completely free to “speak truth to power.”
And she does.
Responding to criticism of her suggestion on 60 minutes, not long ago, of a possible 70% marginal rate on income over $10 million, she responded:
“The question of marginal tax rates is a policy question, but it’s also a moral question,” she said. “What kind of society do we want to live in? Are we comfortable with a society where someone can have a personal helipad while this city is experiencing the highest levels of poverty and homelessness since the Great Depression?”
So, what does it mean to have a 70% marginal rate on income over $10 million? Many are confused about what, exactly, a marginal tax rate actually is. Certainly many on the right seem to not understand it, based on the push-back she has received. I'll explain in a bit how exactly it makes for a healthier economy and a wealthier middle class. But first, I will explain the difference between a marginal tax rate, an effective tax rate, and your actual tax rate.
Vox posted a spot-on video explaining marginal tax rates, which I first found when Ezra Klein shared it on Facebook. I recommend watching this.
Here's how it works for 2019: If you are single, and have no dependents, do not itemize, and are under 65, you have a $12,000 standard deduction. That means that on your first $12,000, you pay no tax. That's right, none.
Going forward in 2019, on the next $9,700, you pay 10%. So if your income is $13,000, you pay no tax on the first $12,000, and 10% on the next $1,000. So your tax on $13,000 would be only $100.
Above that $9,700, you would pay 12% on the next $29,775. So, if you earned $30,000, you pay nothing on the first $12,000, 10% (or $970) on the next $9,700, and then 12% on whatever is above that -- in this case $8,300. -- which is another $996. So, on $30,000, you would pay $970+996, or $1,966 on that $30,000.
What if your income, after subtracting for your 401(k) or 403(b), is $82,000?
Above that $12,000+9,700+29,775 -- above that $51,475, you pay 22% on the next dollar. So, the next $30,525 is taxed at that 22% rate, which is $6,715.
That means that your tax on $82,000 of wages is $0 on the first $12,000, plus 10% of the next $9,700, plus 12% of the next 29,775. plus 22% of the next $30,525. That's $970+3,573+6,715. which equals $11,258. That would be your total tax in this scenario.
Your marginal tax rate in this case is 22%, which is the rate at which your last dollar was taxed.
Your effective tax rate is the rate at which your taxable income --the amount over $12,000, which in this case is $70,000, was taxed. This is$11,258 is the total tax, and when we divide that by the taxable income of $70,000, we see that your effective tax rate is only 16.1%.
And your actual tax rate the tax on the full $82,000, is only 13.7%. Your marginal rate is always going to be higher than both your effective and actual rates.
This means three things:
- That Yoenis Cespedes or Giancarlo Stanton, the highest paid Met and Yankee, get taxed the same amount on that first $70,000 of taxable income as you do, on their way to the $25 million or so that they earn in salary. Their first $70,000 would be taxed at 16.1%, just as you would be on your first $70,000 of taxable income.
- If they reach the suggested marginal tax rate of 70% above $10 million, that will not affect you. You would still be taxed at lower rates on the income you receive.
- Pundits who try to scare you by telling you that you would be taxed at 70% are just, well, trying to scare you.
I hope that makes sense. Watch the video if you can, and feel free to ask me questions if this is not clear.
* * * * *
Now, how do higher marginal rates make for a healthier economy and a wealthier middle class?
Because of priorities. Back in the 1950’s, the highest marginal rate was 90%, on income, that was substantially less than $10 million in today’s dollars. It reduced to 70% in the 1960’s under JFK, then to 50% under Reagan, and then Reagan reduced the top marginal tax rate, in 1987, to a mere 28%.
Did it help the economy? No.
Even Forbes, “The Capitalist’s Tool,” understands that lower taxes does not correlate with economic growth.
It does correlate with “Greed.”
With low tax rates, and low capital gains rates, the US has shifted from an economy that produces goods and services to an economy that produces financial instruments. And, as Forbes notes in their article, “While general observations can be made, it would be inaccurate to draw any firm conclusions between top tax rates and economic growth.”
The article does note that, with higher marginal rates, the incomes of the highest earners decline. That is very significant.
With the marginal tax rate at 90% for income over $100K at the time, CEO's didn't attempt to cannibalize the company by siphoning billions in compensation while laying off workers. Because the marginal tax rate was so high, deferred compensation was crucially important, and, with incentives to save tax dollars, both corporations and individuals invested in defined benefit pension plans, not 401(k)'s. Instead of paying the top executives millions and laying off workers to maintain their lifestyles, the CEO's recognized that the best way to avoid taxes was to pay employees a living wage and invest in their companies' own infrastructure.
The 28% rate in 1987 changed all that. Now, we had nouveau riche. We started to watch Lifestyles of the Rich and Famous on TV. Arbitrage, Leveraged buy-outs, junk bonds, they all hit the economy, as management started to cannibalize its own businesses in order to pay themselves and cash out. With the transition away from manufacturing to financial services, factories started closing here with increased frequency, and moving overseas, with the globalization that came with the increase in focus on the finance industry. America became a country that stopped producing goods, but started instead growing money from money, and reducing the rest to the service industries to support everything else.
And, as the bumper sticker read, He who died with the most toys won.
Prior to the reduction of the highest marginal rate to 70% under JFK, to 50% under Reagan, and then top 28% in 1987, excess profits went into salaries and the physical plant, to avoid higher taxes. Now, it went into the pockets of those extolled by Robin Leach.
With low tax rates, and low capital gains rates, the US has shifted from an economy that produces goods and services to an economy that produces financial instruments.
To understand why this is true - why trickle down economics does not work - let's take $40 million dollars. Let's give $20 million to one, I dunno, hedge fund manager, or CEO of a Fortune 100 company, or a Major League All-Star. Let's divide the other $20 million among 50 guys each earning $200k each, and another 100 people earning $100k each. So we have 1 guy earning $20 million, and 150 people splitting the other $20 million. I'm having these 150 people earn a decent salary, so that we don't confuse the issue by dividing it among people who earn $9 an hour. These 150 people are reasonably well off.
Even so, my question is this: which $20 million will better stimulate the economy? How many more cars, refrigerators, dinners out, movie tickets, etc., etc., will one $20 million purchase compared to the other? Most likely, the guy who earns the $20 million himself won't spend much of it. He or she will probably do some, maybe by a car or two, but will primarily invest it, which means that he or she will exchange the money for a different means of exchange - a stock or bond on the secondary market, for example. He or she might just sock it away in the Cayman Islands. It's the concentration of the wealth among a smaller and smaller population.
Henry Ford, for all his faults (and there are plenty), knew that he had to figure out a way to pay his workers enough to buy his cars. Having more people earn that $20 million will cause more cars to be bought. Having fewer people earn that $20 million concentrates that money into fewer hands, and there are only so many cars, refrigerators, homes and dinners out that one family can purchase in a year, compared to 150 families, let alone more, if we spread it out a bit.
I have a good friend who is a libertarian, who asked me, then, "How much should we tax people earning over $250K?" Maybe it should be 90%, as it worked well under Eisenhower. Or 70%, as it worked well under Kennedy - who had a balanced budget - and LBJ, when the economy was soaring as well. Or 39.6%, which was where it was under President Clinton, when, once again, the economy was booming.
The issue is not tax rates, nor taxes collected. Not by itself. Nor is spending. The issue is two-fold, as Representative Ocasio-Cortez notes way up top. It is a policy question, and also a moral question. I repeat it here because it is worth repeating.:
“What kind of society do we want to live in? Are we comfortable with a society where someone can have a personal helipad while this city is experiencing the highest levels of poverty and homelessness since the Great Depression?”
It’s worth asking:
What kind of society do we want to live in?
That really is the question.