What America needs is more tax brackets, not fewer.

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Nov. 18 2010 6:30 PM

Forget Tax Simplification

What America needs is more tax brackets, not fewer.

Tax simplification is back in vogue among right-thinking people.

On Nov. 10, former Sen. Alan Simpson, a Republican, and Erskine Bowles, former chief of staff to President Clinton, released a draft proposal that they're trying to sell to members of a bipartisan deficit-reduction panel created by President Obama. Chairmen Bowles and Simpson floated the idea of replacing the current six income-tax brackets with three, dropping the top marginal rate (applied to family income above $363,650) from the current 35 percent to 24 percent. Bowles and Simpson also floated a variation previously proposed by Sens. Ron Wyden, D-Ore., and Judd Gregg, R-N.H., that would replace the current structure with three brackets but would keep the top rate at 35 percent. On Nov. 17 a different bipartisan deficit-reduction panel, chaired by former Sen. Pete Domenici, a Republican, and Alice Rivlin, former budget director to President Clinton, released its own report. Domenici and Rivlin propose to replace the current six brackets with two, dropping the top marginal rate to 27 percent.

Perhaps you're wondering why two separate deficit commissions would choose to tackle the deficit by lowering the top tax rate (or at best maintaining it) rather than raising it. The answer has more to do with politics than economics. The idea is to con voters into thinking they're getting a tax cut when in fact they're getting a tax increase through the elimination of various "tax expenditures" (i.e., deductions and exemptions). All these proposals would, for instance, either limit or eliminate the popular mortgage interest deduction. Lowering tax rates to draw attention away from the elimination of tax expenditures was the strategy of the 1986 tax reform bill. That bill was also sold as tax simplification, since it replaced the existing 14 rates with five (dropping the top rate from 50 percent to 38.5 percent) and eventually with two (with a top rate of 28 percent). In the 1990s and aughts, two brackets became three, then five, and finally six.

I'm all for eliminating wasteful tax expenditures. But eliminating them in exchange for lower rates and fewer brackets makes a lot less sense today than it did in 1986 because circumstances have changed in two important ways.

First and most obviously, such a swap isn't nearly so good a deal when the top rate starts out pretty low. In 1986 the top rate was 50 percent. Today the top rate is 35 percent. And if the Bush tax cut is allowed to expire for top incomes (as appears unlikely, at least in the near term), the top rate will rise to 39.6 percent. Even 39.6 percent is low compared with the top rate for most of the income tax's 97-year history. The top rate stood at or above 90 percent between 1944 and 1963. President Kennedy dropped it to 77 percent and then 70 percent, where it remained until 1982, when President Reagan dropped it to 50 percent and then (under the 1986 tax reform) to the aforementioned 38.5 percent and 28 percent. (The first President Bush and President Clinton nosed it back up, first to 31 percent and then to the now-intolerable 39.6 percent, which Bush fils dropped to the present 35 percent.)

Maybe you feel we should write the high rates off as an aberration of the socialist New Deal and its four-decade aftermath. But from 1920 to 1924 the top marginal rate was 73 percent, then 58 percent, then 46 percent. For most of that time the president was Republican Warren G. Harding! Today, combined U.S. taxes at the federal, state, and local level are lower than they are in virtually the entire developed world. A 2008 survey of member countries by the Organization for Economic Cooperation and Development ranked the U.S. two notches from the bottom; only Turkey and Mexico had a lower combined tax rate.

Chart.

The second circumstance that's changed since 1986 is income distribution.

As I pointed out in my Slate series, "The Great Divergence," incomes have grown dramatically less equal since 1979. There are various reasons for this, most of which I won't get into because they're explained in the series. But one very significant reason, especially since the early 1990s, has been a stunning increase in incomes at the top of the income scale. This was first documented by economists Thomas Piketty and Emmanuel Saez in 2003  (see chart above); Saez updated the figures this past July. Since 1979, the share of national income going to the top 0.1 percent (people making more than about $1 million in current dollars) has essentially quadrupled, from about 2 percent to about 8 percent. Let me say that again: About 8 percent of all the income earned in the United States goes to people making $1 million or more. These people don't need tax simplification. They need tax complication: more brackets at higher rates.

The current system of tax brackets is faulty, just like the reformers say it is. But the problem isn't too many tax brackets. It's too few. The income-tax structure we have today is built on the quaint assumption that people earning in excess of $363,650 constitute a single wealthy class. But what Piketty and Saez demonstrated was that this group in fact encompasses a hierarchy of wealthy people whose incomes, like those of the general population, have grown less equal than they were 30 years ago, or even 24 years ago. Here's how James Surowiecki, using the same Piketty-Saez data (and drawing the same conclusion I am here) put it in an August column for the New Yorker: "[A]t the same time that the rich have been pulling away from the middle class, the very rich have been pulling away from the pretty rich, and the very, very rich have been pulling away from the very rich."

We need at least a couple of new higher-percentage brackets above the current highest bracket to acknowledge this reality. It simply isn't fair to treat a family earning $363,650 the same as a family making $1 million. Such families barely live on the same planet. Which isn't to say that the family earning $363,650 deserves a tax cut. It is merely to say that the family earning $1 million should pay more than 35 or even 39.6 percent, and that a family earning $10 million should pay at an even higher tax rate. Stepping it up gradually to a maximum rate of 70 percent would probably cause mass hysteria, at least in the Fox newsroom, but under Nixon and Ford, you paid that much if you earned about $200,000 (the equivalent of somewhere between $800,000 and about $1 million in current dollars). Today that group pays a top marginal tax that's half what it was back then.

By all means, let's eliminate wasteful tax expenditures from the U.S. income-tax system. I'd even favor eliminating the mortgage-interest deduction (though perhaps not at this precise moment, given the perilous state of the housing market). But please, let's hear no more talk about reducing the number of tax brackets. We need more tax brackets, and higher ones, for the rich, richer, and richest. They can afford it.

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