"Taxing the 1%: Why the top tax rate could be over 80%"

Figure 2. GDP-per-capita growth rates and top marginal tax rates since the 1970s

​An article from VoxEU reports,

​Figure 2 shows that there is no correlation between cuts in top tax rates and average annual real GDP-per-capita growth since the 1970s. For example, countries that made large cuts in top tax rates such as the United Kingdom or the United States have not grown significantly faster than countries that did not, such as Germany or Denmark. Hence, a substantial fraction of the response of pre-tax top incomes to top tax rates documented in Figure 1 may be due to increased rent-seeking at the top rather than increased productive effort.

Naturally, cross-country comparisons are bound to be fragile, and the exact results vary with the specification, years, and countries. But by and large, the bottom line is that rich countries have all grown at roughly the same rate over the past 30 years – in spite of huge variations in tax policies. Using our model and mid-range parameter values where the response of top earners to top tax rate cuts is due in part to increased rent-seeking behaviour and in part to increased productive work, we find that the top tax rate could potentially be set as high as 83% – as opposed to 57% in the pure supply-side model.

Up until the 1970s, policymakers and public opinion probably considered – rightly or wrongly – that at the very top of the income ladder, pay increases reflected mostly greed or other socially wasteful activities rather than productive work effort. This is why they were able to set marginal tax rates as high as 80% in the US and the UK. The Reagan/Thatcher revolution has succeeded in making such top tax rate levels unthinkable since then. But after decades of increasing income concentration that has brought about mediocre growth since the 1970s and a Great Recession triggered by financial sector excesses, a rethinking of the Reagan and Thatcher revolutions is perhaps underway. The United Kingdom has increased its top income tax rate from 40% to 50% in 2010 in part to curb top pay excesses. In the United States, the Occupy Wall Street movement and its famous "We are the 99%" slogan also reflects the view that the top 1% may have gained at the expense of the 99%.
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In the end, the future of top tax rates depends on the public's beliefs of whether top pay fairly reflects productivity or whether top pay, rather unfairly, arises from rent-seeking. With higher income concentration, top earners have more economic resources to influence social beliefs (through think tanks and media) and policies (through lobbying), thereby creating some reverse causality between income inequality, perceptions, and policies. We hope economists can shed light on these beliefs with compelling theoretical and empirical analysis.