Friday, September 11, 2015

Idle rich

National Review's Ramesh Ponnuru, in the course of making an overall sensible argument against magical thinking on the impact of tax cuts --

When Reagan took the top tax rate from 70 to 50 percent in his first term, it increased the after-tax return on a dollar earned by 67 percent. (I’m leaving out state and local taxes for convenience.) When he cut it again to 28 percent in his second-term tax reform, that return increased by another 44 percent. But when Clinton took the top rate from 31 to 39.6, it lowered that return by only 12 percent. It should not have been expected to have terrible effects. And it shouldn’t have been surprising that any negative effects it had were overwhelmed by other trends, such as favorable demographics, falling energy prices, and technological change, among others. 

So when Reagan cut taxes, the effect was big because the percentage change in top rate was so large, while when Clinton raised taxes, it didn't hurt because the percentage change was small and other favourable things -- unlike the 1980s, apparently -- were going on.

The problem is that his logic is double edged. If cutting the top rate from 70 to 50 percent increases after tax return on an additional dollar by 67 percent, it also increases the return on every existing dollar taxed at the top rate by 67 percent. And the more you were earning already before the tax cut, the bigger that effect is. So the high earners don't have to work any harder to earn the same income as before, muting any effects on growth.

One of the mysteries of conservative economics is that the rich are always considered to need more money to make them work harder, while the poor need less money to make them work harder. In the real world, it's the opposite.

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