Opinion | Why the 70% marginal top tax rate won’t work in the US4 min read . Updated: 14 Jan 2019, 10:53 PM IST
Unless all aspects, like tax arbitrage, are coordinated, raising the rate won't deliver social justice
Alexandria Ocasio-Cortez, or AOC, is a Congresswoman in the United States. She is the toast of the town in America. She ticks all the boxes—minority, woman, qualified, competent and articulate, and has a mind of her own. Part of the adulation is explained by the perception that, in the eyes of Democrats and those who oppose US President Donald Trump, she is the opposite of all that Trump stands for. She recently proposed a 70% top marginal tax rate in the country to deal with the costs of climate change or to fund a “Green New Deal". While Europe is resolutely turning nationalist, America is turning socialist, notwithstanding the fact that monetary policy is in thrall to financial markets.
Paul Krugman, columnist for The New York Times, was quick to weigh in with an op-ed, The Economics Of Soaking The Rich, on 5 January. The chart used by Krugman in his piece, defending the 70% top marginal tax rate suggestion of Congresswoman Alexandria Ocasio-Cortez, and his interpretations of the chart are the stuff of quiz questions for undergraduate students in economics.
He wrote: “What we see is that America used to have very high tax rates on the rich—higher even than those AOC is proposing—and did just fine. Since then, tax rates have come way down and, if anything, the economy has done less well." Krugman knows what he is doing. He is taking enormous liberties with interpretations and, in the process, he is doing a very big disservice to his readers. In other words, he does not think very highly of their intelligence.
ln the 1950s and 1960s, America was doing fine and that is why its governments could get away with such high marginal top tax rates. It did not matter as much as it would have, under less-favourable growth circumstances. Second, correlation is not causation. There is no causality between tax rates coming down and the structural growth slowdown. There is no model, theory or logic that posits that. If anything, it is possible to argue that the growth rate would have been even lower without the lower tax rates as all the low-hanging fruits of economic growth had been plucked in the 1970s (since the end of World War II).
Even if the 70% top marginal tax rate would have worked before, it does not mean that it would work again. Circumstances and context matter, and they keep changing all the time. That is why all economic theories come with the caveat, “Ceteris Paribus". Experts do not make the world better by allowing defunct political ideologies to enslave them. Monkeys do not swing from one broken branch to another. We swung from interventionist growth to laissez-faire growth and, again, we are swinging back towards more interventions.
All these models came with their big baggage of weaknesses. They appeared to work for a time because the context was favourable. High taxes, high wages and high investment could prevail in tandem, post-World War II, because economic growth was easy to obtain. Similarly, the onset of the Reagan-Thatcher capitalist counter-revolution was a reaction to the weaknesses of the post-World War II order that became too stark, once growth ebbed. Now, the context for the proposal from the congresswoman is the last 35 years of laissez-faire capitalism that has become barely distinguishable from robber-baron capitalism.
The adulation and admiration that Ocasio-Cortez commands now is a direct reflection of the extent of disillusionment with the failures of capitalism as it has evolved in the last four decades.
The growth of the financial sector, the rise of the culture of debt and exorbitant executive compensation were not just its distinguishing (hardly redeeming, however) characteristics. In the last quarter century, these developments have been accompanied by the rise of the technology sector, market concentration and loss of consumer power along with the loss of privacy.
Laissez-faire economics was supposed to take us closer to the ideal of perfect competition, which maximized the area under consumer surplus. But we have gone back in time to the 19th century when capitalists gorged on the state and the society. The backlash is the proposal such as a 70% marginal top tax rate. Unfortunately, it won’t work, simply because not all countries will play by the same rules. There will be tax arbitrage and capital is mobile. Unless all of these aspects are coordinated, merely raising the top marginal tax rate will not deliver social justice or a better climate.
Internationally, we need another Bretton Woods-type conference to fashion a new deal—a new economic order—and not just a monetary order. Visionary capitalists, who can think beyond their next quarter’s profits or their stock options, and are capable of weighing long-term interests correctly, must take the lead and set personal examples for others to follow.
If the moral compasses of America’s capitalists and elites are so broken that they cannot do this, then the 70% top marginal tax rate is just the beginning. Capturing the Federal Reserve will not be enough.
V. Anantha Nageswaran is the dean of IFMR Graduate School of Business (KREA University). These are his personal views.