High taxes for the rich may distort innovation1 min read . Updated: 17 Jan 2019, 11:03 PM IST
An 'optimal top tax rate' is one that balances the welfare benefits from wealth redistribution with the costs of lower economic activity that a tax induces
Mumbai: The average Amazon employee in the US earns $28,000 every year. Their CEO, Jeff Bezos, makes more than that every 10 seconds, according to a news report in Time .
Given this inequality, it may seem understandable then, that extravagant incomes such as Bezos’s be taxed more to redistribute wealth. However, a new study by Charles I. Jones of Stanford Graduate School of Business suggests that taxing the likes of Bezos more may be counterproductive for the economy.
He suggests that levying high tax rates on the incomes of top earners can discourage innovation and reduce economic welfare. This is because innovative business ideas increase productivity across the economy and, consequently, drive growth. For example, the computer code behind the first spreadsheet has made millions more productive. So, when innovators are discouraged from working, this can reduce everyone’s income, not just the income at the top. Jones argues that typical calculations of optimal tax rates do not take into account the economic loss from less innovation and ideas.
An ‘optimal top tax rate’ is one that balances the welfare benefits from wealth redistribution with the costs of lower economic activity that a tax induces. In the study, Jones argues that current estimates have overestimated the optimal tax rate because they do not consider changes in innovation. Including the contribution of innovation and ideas to the economy, he finds that the optimal top tax rate in the US would be significantly decreased. In fact, he suggests that if ideas play an even more important role in economy, this could justify a negative tax rate.
This would mean essentially subsidizing top earners because the overall increase in growth they generate through their ideas would outweigh the cost of not taxing them. While the study does not provide a value on what is the ‘right’ tax rate for top earners, it does highlight the importance of innovation and ideas in tax rate calculations.
Also read: Taxing Top Incomes in a World of Ideas