It is pretty clear that if the U.S. economy is to be rebalanced so as to adequately fund health care, education, other social services and infrastructure, the direction of fiscal policy must be reversed. And the key element of the needed reversal is a reevaluation of taxes on the rich – certainly the 1 percent, maybe the 5 percent or 10 percent. There is no other source of additional funds to turn to, and increased starvation of public services would be harmful to the whole country.
But standing in the way of any rethink of taxation has been the view of economists that the disincentive effects of higher tax rates would outweigh the advantages. In the extreme case proposed by Arthur Laffer and depicted in his famous chart on a dinner napkin, increases in tax rates would reduce the tax base to such an extent that the amount of tax collected would actually drop. This kind of "analysis," which influenced President Reagan and his advisors, continues to influence economists to this day, and more importantly justifies the knee-jerk opposition of so many politicians (and voters) to tax increases. John Maynard Keynes remarked, in the concluding notes of his "General Theory," that "the ideas of economists and political philosophers, both when they are right and when they are wrong , are more powerful than is commonly understood…Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back."
While Keynes concluded, in the final sentence of his book, that "it is ideas, not vested interests, which are dangerous for good or evil," we don't need to argue about the relative dangerousness of these two influences in the tax arena. What we have suffered from in the decades since 1980 is a massive right-wing conspiracy of both the economic ideologues and the vested interests. The debate has gotten so distorted that it has become very difficult politically to argue for higher tax rates; the arguments in favor of increasing taxes generally run along the lines of further reducing tax rates, while closing tax loopholes.
But now perhaps the times they are a-changin. Exhibits A and B are articles by economics heavy hitters including Peter Diamond of M.I.T. and Emmanuel Saez of Berkeley. In a National Bureau of Economic Research working paper titled "Optimal Taxation of Top Labor Incomes : a Tale of Three Elasticities," Saez and two co-authors conclude that "socially optimal top tax rates might possibly be much higher than what is commonly assumed." And Diamond and Saez, in an article in the American Economic Association's Journal of Economic Perspectives (http://www.aeaweb.org/articles.php?doi=10.1257/jep.25.4.165), conclude that "very high earners should be subject to high and rising marginal tax rates on earnings."
An interesting feature of these findings is that they are quite extreme in the sense that they argue for the "optimality" of much higher effective tax rates than are currently in effect. This makes room for "directional" changes that move in the direction of "optimality" without necessarily going as far as the levels indicated by these studies. Generally, it is wise to apply pragmatic "reasonableness" tests to economic policies, including tax policies. It simply doesn't seem reasonable, even to somebody like Warren Buffett who is one of them, for multi-millionaires or billionaires to pay income taxes at an effective rate of below 15 percent. On the other hand, there is some upper level – 60%? 80%? --beyond which marginal tax rates would seem unreasonable. One can never please everybody, but there is a wide range of rates that might seem reasonable to a vast majority of Americans.
There are several factors that enter into the assessment of "reasonableness" when it comes to tax rates and fiscal policy as a whole. One is what alternatives to proposed tax increases are available. Another is the state of the country: How bad is the decline in education standards? How underfunded is road and railway infrastructure? The answers to questions of this kind will influence how much people are willing to push on the taxation front, how much they will regard as "reasonable."
Let's see how the debate develops. Hopefully, the times they are a-changin.
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