Top Marginal Tax Rates: 1958 vs. 2009

Top marginal income tax rates used to be much higher back in the 1950s and 1960s. How much revenue did those higher tax rates actually collect? Daniel Baneman and Jim Nunns address that question in a short report,\”Income Tax Paid at Each Tax Rate, 1958-2009,\” published by the Tax Policy Center last October.

 For starters, take a look at the statutory tax brackets for 1958 and 2009. The The tax brackets are adjusted for inflation, so the horizontal axis is constant 2009 dollars. The top statutory tax rate in 2009 was 35%; back in 1958, it was about 90%.  Marginal income tax rates are lower across the income distribution in 2009. In addition, the top marginal tax rate occurs much lower in the income distribution in 2009 than it did in 1958.

How many households actually paid these rates? Here\’s a figure showing the share of taxpayers facing different marginal tax rates. At the bottom, across this time period, roughly 20% of all tax returns owed no tax, and so faced a marginal tax rate of zero percent. Back in 1958, the most common marginal tax brackets faced by taxpayers were in the 16-28% category; since the mid-1980s, the most common marginal tax rate faced by taxpayers has been the 1-16% category. Clearly, a very small proportion of taxpayers actually faced the very highest marginal tax rates back 1958. It\’s interesting to note how the share of taxpayers facing higher marginal rates expanded substantially in the 1970s, probably due in large part to \”bracket creep\”–that is, tax brackets at that time didn\’t increase with the rate of inflation, so as wages were driven up by inflation, you were pushed into higher tax brackets even though real income had not increased.    

How much revenue was raised by these high marginal tax rates? Although the highest marginal tax rates applied to a tiny share of taxpayers, marginal tax rates above 39.7% collected more than 10% of income tax revenue back in the late 1950s. It\’s interesting to note that the share of income tax revenue collected by those in the top brackets for 2009–that is, the 29-35% category, is larger than the rate collected by all marginal tax brackets above 29% back in the 1960s.

A few quick thoughts:

1) Perhaps it goes without saying, but there\’s no reason to think that 1958 was the high point of social wisdom when it comes to tax policy. In addition, the economy has evolved considerably since 1958: talent and tasks are probably more mobile, and methods of categorizing income in ways that affect tax burdens have become more sophisticated. Also, the distribution of income has become much more unequal in recent decades, and so arguments over the appropriate share of taxes to be paid by those in the top income groups have evolved as well.

2) Raising tax rates on those with the highest incomes would raise significant funds, but nowhere near enough to solve America\’s fiscal woes. Baneman and Nunns offer this rough illustrative estimate: \”If taxable income in the top bracket in 2007 had been taxed at an average rate of 49 percent, income tax liabilities (before credits) would have been $78 billion (6.7 percent of total pre-credit liabilities) higher, taking into account likely taxpayer behavioral responses to the rate increase.\” The behavioral response they assume is that every 10% rise in tax rates causes taxable income to fall by 2.5%.

3) If one wants to use the 1958 example as a precedent, it would be fair to point out that the lowest-bracket income tax rates are a fairly new development, as of the mid-1980s. One could also use the example of 1959 to argue that many more taxpayers in the broad range of lower- and middle-incomes should face marginal federal tax rates in the range of 16-28%.

4) If the goal is to raise more tax revenue from those with high incomes, higher tax rates are not the only method of doing so. For example, one could limit various tax deductions that apply with greatest force to those high up in the income brackets. One could also look at ways in which the tax code lets those with high incomes pay lower rates, like the lower tax rates for capital gains and on tax-free investments like state and local bonds.

Same Income, Varying Taxes: ERP #4

This is the fourth of four posts based on figures from the 2012 Economic Report of the President. For the first post and an overview, start here.

Amid the complexity and confusion of the U.S. income tax code, it\’s quite possible for people with similar levels of income to pay widely varying level of tax. For illustration, consider the table. The rows of the table divide up the U.S. income distribution into fifths, or quintiles. The last row shows results for the top 1% of the income distribution.  For each quintile–and for the top 1%–the columns of the table then tell about the distribution of taxes for that group.

For example, if one looks at the distribution of average tax rates for the bottom quintile, households at the 10th percentile of that distribution have a federal tax rate of -13.7% (that is, they receive refundable tax credits from the government). In the bottom quintile of the income distribution, those at the median pay 5.4% of income in federal taxes. (These calculations include income taxes and payroll taxes.)

Or look at the top 1%. Given the distribution of federal taxes for that group, the household at the 10th percentile of tax payments for this group pays 8.7% of income in federal taxes (presumably due to substantial tax-free investments, or perhaps to carrying forward losses from a previous tax year that count against income in this year). However, a household in the top 1% of the income distribution and the 90th percentile of the tax distribution for this group pays an average federal tax rate of 34.6%.

At least for me, there is something of a tendency when looking at tables like this one to feel as if some of those with high income are paying too little, and some of those with low incomes are paying too much. And maybe that quick reaction is correct. But the tax code has so many rules and provisions and exceptions and situations, that it\’s s also possible that if I knew the actual details of some of these taxpayers, the outcome would seem fairly reasonable to me.

The broader point here is that when a tax code becomes enormously complex and lengthy, it is also going to allow the possibility of considerable variation in taxes paid even for those with similar incomes. Even if all the individual provisions of such a tax code are defensible (an enormous \”if\”!), the tax code as a whole is likely to end up appearing arbitrary and unfair.

A Soft Drinks Tax?

The October 2011 issue of Choices, published by the Agricultural and Applied Economics Association, has a set of six short readable articles on the subject: \”Should Soft Drinks Be Taxed More Heavily?\”

The case for taxing soft drinks–or as some of this literature puts it, SSBs (sugar-sweetened beverages)– is based on a hope that taxes on sugary beverages would reduce obesity and improve public health. Jason Fletcher cites some striking evidence (citations omitted here and throughout):  \”[S]oft drink consumption has increased by almost 500% in the past 50 years, and recent data suggest it represents 7% of overall energy intake in adults and often larger proportions in children … a 16% share of calories in youth ages 12-19 and 11% in children ages 2-11.\” Carlisle Ford Runge, Justin Johnson, and Carlisle Piehl Runge write: \”U.S. sugar-sweetened sodas account for one-half of the increase in caloric consumption over the past 25 years, and are the largest source of added sugars in the average diet …\”

 Reducing calories by a small amount, if sustained continually, would bring down weight. Fletcher again: \”We know that soda consumption is an important share of total consumption, and ample evidence suggests that maintained reductions in consumption of approximately 100 calories per day—less than a can of soda—could halt weight gain for 90% of the population …\”

Jason P. Block and Walter C. Willett cite a number of studies which estimate a price elasticity of demand for soda, often finding estimates in the range of .7 or .8–that is, a 10% rise in the price of the soda would lead to a decline of 7 or 8% in the quantity consumed.

The main counterargument is that when people cut back on soda or soft drinks, they don\’t switch to drinking water. Instead, most of them will shift to other equally caloric beverages, including cheaper brands of soft drinks, sugary fruit waters, and juices or milk. As a result, calorie intake won\’t drop. Fletcher one more time: \”[T]here is now ample research that examines the association between the level of state soft drink taxes—or soft drink prices—and obesity rates and found no effect. … [W]hile individuals in states with higher soda taxes have lower soda consumption, these individuals completely offset the reductions in calories from soda by consuming other high-calorie beverages, such as milk and juice. This evidence is consistent with the view that individuals demand calories each day, and if the price increases on one mechanism of attaining calories (soda) then individuals shift their consumption relatively easily to satisfy their demand.\”

There is also some evidence that there may be mildly positive health effects from a soda tax, but at best, the empirical evidence that an SSB tax would improve health is questionable and uncertain. Indeed, it may be that those who most need to lose some weight are also the group who would be most likely to substitute toward other caloric drinks.

Even if a sugar-sweetened beverage tax didn\’t reduce obesity, it might have some side benefits. For example,
Runge, Johnson, and Runge have an essay titled: \”Better Milk than Cola.\” Their point is that drinking milk or orange juice provides some other nutrients, even if the calorie count is the same, rather than just empty sugar. There may be dental health benefits, too.

Is there a way to make sugar-sweetened beverage taxes into a more useful policy tool? There are a number of possibilities. First, an obvious possibility would be to have higher taxes on sugar-sweetened beverages, and to focus them on those beverages in particular, not on all soft drinks.  Block and Willett point out that \”the inflation-adjusted price of soda has declined by as much as 48% over 20 years.\”

At present, lots of states apply their sales taxes to soft drinks. But usually such taxes are not specific to sugar-sweetened beverages vs. diet or low-calorie drinks. In addition, such taxes are not usually very large, and so are unlikely to have much effect on behavior. Here is Frank J. Chaloupka, Lisa M. Powell, and Jamie F. Chriqui (citations omitted): \”[V]ery few governments, including seven U.S. states, levy small taxes that are unique to soft drinks and other non-alcoholic beverages, and almost none of these, including the few state taxes, apply only to sugar-sweetened beverages.  However, most governments do impose their value added or sales taxes on a variety of beverages, with about two-thirds of U.S. states levying sales taxes on carbonated soft drinks. Again, none of these differentiate sugar-sweetened from unsweetened or artificially sweetened beverages. Given the low sales tax rates in the United States, these taxes add very little to retail prices, on average accounting for less than 5% of the tax inclusive price.\” A true SSB tax would presumably focus on sugar-content or calorie count.

A number of the essays point out that there may be interactions with public information campaigns or advertising and a soda tax. For example, publicity about the soda tax might help to make the tax salient in the minds of the consumers, so that they react to it more strongly. Publicity about healthier alternatives might also help in making healthier substitutions. Joshua Berning points out that soft drink companies spend tens of milllions each year on television advertising for top brands, which certainly suggests that advertising can influence choices. It also suggests that a tax on sugar-sweetened beverages could be undercut or offset by changes in advertising strategy.

One concern sometimes raised about a tax on sugar-sweetened beverages is that if people switch to diet soda, that might also have some negative health effects. However, studies of health effects of drinking diet soda need to account for two-way causality: that is, it may be that drinking diet soda causes poor health, or it may be that those who are already in poor health are more likely to drink diet soda. Block and Willett write: \”When all of these studies are considered together, it appears that many, if not all, of the apparent adverse effects reported for artificially sweetened beverages may be due to reverse causation—individuals may switch to artificial sweeteners because of weight gain or blood glucose abnormalities. The studies that properly account for possible reverse causation, by using longitudinal data on subjects over time and controlling for dieting behaviors and weight, find no clear association between artificially-sweetened beverage consumption and metabolic risk.\”

The final essay, by Robbin Johnson, offers a counterargument to the idea of a soft drink tax. He points out that there are lots of contributors to obesity: \”spending too much time sitting down watching screens; a physical environment that promotes vehicle use rather than walking; competition for the dining-out dollar that leads to larger portion size; lack of access to healthy foods or individualized portions; advertising messages promoting processed, calorie-dense foods; genetic factors; hormonal or other metabolic causes; use of medicines that contribute to weight gain; emotional needs that encourage overeating; quitting smoking; sleeping too little or too much; and aging.\” Most advice about weight loss and good health is about taking responsibility for moving toward an overall healthy lifestyle, not about identifying certain foods as \”bad foods\” and taxing them.

A \”bad foods\” tax, after all, would probably also focus on potato chips, french fries, snacks, candies, desserts, and processed meat, along with sugar-sweetened drinks, A \”bad lifestyles\” tax would tax or subsidize all sorts of actions. Leave aside the practical difficulties of designing and administering a bevy of such taxes. The conceptual insight is that these taxes would affect many foods and actions that are not bad for your health if done in moderation. There is something of a mismatch between a bevy of taxes to micromanage food and lifestyle choices for the average person, and the goal of discouraging the minority who are obese from overconsuming.

The Misguided Financial Transactions Tax: Future of Banking #2

Thorstein Beck has edited an e-book for Vox on \”The Future of Banking.\” It consists of 12 short and highly readable essays by expert economists, based on their academic research. The book is packed full of interesting and relevant analysis. This is the first of three posts on a few of the ideas that jumped out at me. The topics of the three posts are:

1) The dangers of persistently low interest rates
2) The misguidedness of a financial transactions tax
3) The rise of global banks in emerging markets

Proposals for a financial transactions tax are a hardy perennial topic. The European Commission proposed one in late September. Even the Vatican has gotten into the act by publicly supporting such a tax, a proposal I reviewed and critiqued in an October 28 post, \”Financial Transactions Tax: The Vatican vs. the IMF.\” In this book, Thorsten Beck and Harry Huizinga offer an overview of why such proposals are misguided policy in \”Taxing banks – here we go again!\”

There are two main arguments for a financial transactions tax: 1) by discouraging high-frequency financial transactions, it will encourage financial stability; 2) it could raise a lot of money at a time when government budgets are stressed.

The first argument is probably incorrect. As Beck and Huizinga explain:

\”As pointed out by many economists, transaction taxes are too crude an instrument to prevent market-distorting speculation. On the contrary, by reducing trading volume they can distort pricing since individual transactions will cause greater price swings and fluctuations. But above all, not every transaction is a market-distorting speculation. Speculation is not easy to identify. For example, which is the market-distorting bet – one against or for a Greek government bankruptcy? Did the losses of the banks in the US subprime sector occur due to speculation or just bad investment decisions? What is the threshold of trading volume or frequency beyond which it is speculators and not participants with legitimate needs that drive the market price for corn, euros, or Greek government bonds? Most importantly, however, FTTs are not the right instrument to reduce risk taking and fragility in the financial sector, as all transactions are taxed at the same rate, independent of their risk profile.\”

There is good reason to be concerned that excessive leverage can help lead to asset price bubbles and economic instability. But it is not at all clear that the raw number of financial transactions creates financial instability; indeed, it is possible that discouraging financial transactions could lead to greater instability. In this sense, a financial transactions tax is misguided.

If the goal is to raise more revenue from the financial sector, there are other ways to do it. In the European context, Beck and Huizinga point out that one simple approach would be to apply value-added taxes to financial services. They write: 

\”An obvious step towards bringing about appropriate taxation of the financial sector is eliminating the current VAT [value-added tax] exemption of most financial services. The current undertaxation of the financial sector resulting from the VAT exemption is mentioned by the European Commission as a main reason to introduce additional taxation of the financial sector. However, if the problem is the current VAT exemption, isn’t the right solution to eliminate it?\”

Another option for taxing the banking sector is to impose a tax on banks that have high levels of leverage. In a way, this is similar to policies where banks with low levels of capital need to pay higher premiums for their government deposit insurance–that is, it\’s an attempt to make banks face the possible social costs of their risky behavior. Beck and Huizinga refer to this policy as one of \”bank levies\”:

\”Bank levies are taxes on a bank’s liabilities that generally exclude deposits that are covered by deposit insurance schemes. Bank levies appropriately follow the ‘polluter-pays’ principle, as they target the banks – and their high leverage – that are heavily implicated in the recent financial crisis. Bank levies have significant potential to raise revenue and they directly discourage bank leverage, thereby reducing the chance of future bank instability. In sophisticated versions of bank levies, they are targeted at risky bank finance such as short-term wholesale finance, and they may be higher for banks with high leverage, or for banks that are systemically important.\”

In short, proposals for a financial transactions tax are an old nostrum. Whether the goal is enhancing financial stability or raising revenue, or both, better options are available. 

Switching from a fuel tax to a vehicle-miles tax to finance highways?

The U.S. government imposes a tax of 18.4 cents/gallon on gasoline as a main source of financing for the Highway Trust Fund. However, the tax rate hasn\’t been raised since 1993, so inflation has eaten away at its real value. In addition, as fuel economy improves, miles travelled are rising faster than fuel consumption. Thus, the Highway Trust fund has been spending roughly $10 billion more per year since 2008 on highway projects than the fuel tax takes in. Thus, there have been proposals to switch from a fuel tax to a vehicle-miles tax as a way of funding highways. Here are a some thoughts about this policy: 
1) Both a fuel tax and a vehicle-miles tax can be viewed as user fees–that is, those who use the roads are paying for their maintenance and upkeep.
2) A vehicle-miles tax would probably raise more money than fuel tax over time, because vehicle-miles are rising more than fuel consumption. In the Winter 2010-2011 issue of the Rand Review, Paul Sorenson, Liisa Ecola, and Martin Wachs illustrate this point with a figure.
 3) The administrative apparatus for collecting the fuel tax is in place, and there are severe issues with how a vehicle-miles tax would be implemented. Sorenson, Ecola, and Wachs write:  “Mileage-based road use fees could be implemented in various ways, but three options appear to offer the greatest promise: (1) estimating mileage based on a vehicle’s fuel economy and fuel consumption, (2) metering mileage based on a device that combines cellular service with a connection to the onboard diagnostics port, and (3) metering mileage based on a device that contains a global positioning system (GPS) receiver.\” The first method seems a little rough-and-ready, and might need to be collected once a year, perhaps when auto registration is renewed. It would be much more visible to the public than the existing fuel tax. The other two methods raise legitimate privacy concerns: should the government really have the power to track where all cars have gone? One way or another, collection costs are likely to be higher for a new vehicle-miles tax.  

4) A vehicle-miles tax does not reward driving a fuel-efficient automobile–which may help the poor.             The Congressional Budget Office published in March 2011 a comparison of a vehicle-miles tax vs. the existing fuel tax in “Alternative Approaches to Funding Highways.”VMT taxes are qualitatively similar to fuel taxes in their implications for equity. Like fuel taxes, they satisfy the user-pays principle, but they impose larger burdens relative to income on people in low-income or rural households. However, to the extent that members of such households tend to drive vehicles that are less fuel efficient, such as pickup trucks or older automobiles, those highway users would pay a smaller share of VMT taxes than of fuel taxes.” 
5) Trying to sort out the relevant externalities is tricky. The CBO suggests that costs imposed by highway users can be divided up into costs more related to miles travelled and costs more related to fuel use. \”Mileage-related costs, which include the costs associated with pavement damage, congestion,
accidents, noise, and emissions of local air pollutants by passenger vehicles, in fact account for the majority
of total costs. (The costs associated with local air pollution from passenger vehicles are considered mileage
related because those emissions, unlike emissions from trucks, are regulated on a per-mile basis.) Fuel-related costs include the costs of local air pollution from trucks, climate change, and dependence on foreign oil.\” I\’m not sure that a single policy can sensibly address costs of road maintenance and construction, environmental costs of fossil fuels, and costs of congestion. Trucks are much harder on pavement than cars. Contributions to congestion depend on when and where you drive. Pollution is affected by the type of car you drive, not just by miles traveled.
Here\’s a useful CBP table summarizing arguments about taxes on fuel versus taxes on vehicle miles traveled.