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Commentary By Caroline Baum

Raising Top Tax Rates Won't Cure Income Inequality

Economics Finance

Income inequality is a major talking point for Democratic presidential candidates Hillary Clinton and Bernie Sanders. Both want to impose higher taxes on top earners, either directly or indirectly.

Clinton's tax proposals are aimed at upper-income earners. She would impose a 4 percent surtax on households earning more than $5 million a year; close some corporate loopholes; and raise the capital gains tax rate on investments held for less than six years to address what she calls "quarterly capitalism."

Sanders is more direct and egalitarian when it comes to his tax plan. He would raise marginal rates for everyone, to as high as 52 percent for those earning more than $10 million a year. He would tax capital gains and dividends at ordinary income tax rates for households with annual income in excess of $250,000.

Neither candidate has a specific proposal to address the U.S. corporate tax rate, which, at 35 percent, is the highest among industrialized nations. Neither has advocated for the immediate expensing of business investments. (Both are priorities for Republican candidates.) Instead of dangling a carrot - creating an incentive for domestic and foreign businesses to locate, invest, produce and create jobs in the U.S. - both Clinton and Sanders prefer the stick. They would penalize corporations for acting in their shareholders' interest, incorporating overseas to reduce their tax liability.

Clinton would institute an exit tax for corporations looking to leave the United States. Sanders, who at least is credible in his distaste for Corporate America, would tax corporate profits wherever they are generated, domestically or overseas.

If the candidates' solutions for ending corporate inversions seem unnecessarily complex, their cure for income inequality is unlikely to produce the desired results. In a recent Brookings Institution paper entitled, "Would a Significant Increase in the Top Income Tax Rate Substantially Alter Income Inequality?," economists William G. Gale, Melissa S. Kearney and Peter R. Orszag answer, no. Or, in their own words: "An increase in the top tax rate leads to an almost imperceptible reduction in overall income inequality, even if the additional revenue is explicitly redistributed."

The economists use a top tax rate of 50 percent and do not adjust for behavioral changes in response to higher rates. Assuming no change in top earners' incomes, the higher tax rate would yield an additional $95.6 billion in revenue, according to their model.

If all of that revenue were redistributed directly to households in the bottom quintile - $2,650 in after-tax income for each household - the reduction in income inequality is "quite modest" according to the study's authors. "That such a sizable increase in the top personal income tax rate leads to a strikingly limited reduction in income inequality speaks to the limitations of this particular approach to addressing the broader challenge."

For those of us who aren't sophisticated in the workings of econometric models, I suggest a simpler route to the same conclusion. Take a look at a single image: a graph of federal revenues as a share of gross domestic product. Top marginal tax rates have fluctuated widely in the post-World War II era, from a high of 91 percent to a low of 28 percent. Yet the share of revenue that the federal government receives has been relatively stable at 17 percent of GDP. The variation in revenues within a narrow band seems to be more a function of the business cycle than any change in the top marginal rate.

So why bother to fiddle with income tax rates? If the government is unable to command a larger share of the pie, even with a top rate of 91 percent, why not focus on finding the ingredients necessary to bake a bigger pie?

Such a unifying theme is unlikely to ignite the disaffected voters that flock to Sanders' campaign rallies to hear about the rigged economy. It is rigged, but not in the way that's presented. Wealthy individuals and large corporations are adept at using the tax code, with its voluminous loopholes, exemptions and deductions, to their advantage.

Even with creative accounting, the rich still pay the lion's share of the taxes. For example, in 2013 the top 1 percent accounted for 19 percent of total adjusted gross income in the U.S. and shouldered 38 percent of the tax burden. In dollar terms, the top 1 percent paid more ($465 billion) than bottom 90 percent combined ($372 billion).

It should be obvious that the rich don't blithely turn over more income to the U.S. government when their tax rate goes up. They shelter it, exploit economically inefficient loopholes, invest the money overseas or even leave the country themselves.

Those who advocate raising tax rates to extract more revenue from the wealthy need to understand that the rich are different from you and me. They have better tax attorneys.


Caroline Baum is a contributor to e21. You can follow her on Twitter here.

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