A popular suggestion is that raising taxes only on high earners (for example, the top one percent – households that make above roughly $435,000 annually) would fix the debt problem. Although revenue from high earners could contribute to the solution, it is unlikely to be enough to fully solve our debt problems. This is particularly true if efforts to raise income from high earners come primarily from raising individual income tax rates.
To provide a generous estimate of the revenue that can be raised by increasing tax rates on higher earners, we extrapolated estimates for a 1 percentage point tax increase provided by the Congressional Budget Office. These numbers will significantly overstate the revenue potential of raising rates since they do not account for the large behavioral effects likely to occur as the top tax rises.
By our math, achieving a balanced budget by 2025 by raising the top two rates – those which only apply to income significantly above $400,000 – would require increasing the top individual tax rate from 39.6 percent to about 102 percent. This is an obvious impossibility, since few taxpayers would continue to work at a 100 percent tax rate.
A more modest goal of reducing deficits to their pre-recession historical average of about 2.2% of GDP (enough to put the debt on a modest downward path) would require a top rate of 65%. In reality, that would likely also be impossible as rates at that level would lead to significant (legal and illegal) tax avoidance strategies and lower work effort and labor force participation. In fact, based on estimates from liberal economists Peter Diamond and Emmanuel Saez, the revenue-maximizing individual income tax rate is likely about 63 percent (they estimate 73 percent including state, local, and Medicare taxes).
Expanding the set of taxpayers subject to a tax increase would make it easier to hit any given fiscal target. Balancing the budget only from households making above $250,000 would require a (still impossible) 90 percent top rate, but reducing deficits to 2.2 percent of GDP would require a 60 percent top rate and might be achievable. Expanding the universe to couples above $150,000 would reduce the needed top rate to 56 percent and applying the increase to all tax brackets would require a top rate of 43 percent – only 3½ point higher than today’s top rate.
|What Would the Top Income Tax Rate (currently 39.6%) Need to Be to Achieve Certain Fiscal Targets?|
|Deficit Target in 2025|
(0% of GDP)
Pre-Recession Share of the Economy
(1.1% of GDP)
Pre-Recession Historical Average
(2.2% of GDP)
Maintain Current Deficits as a Share of the Economy
(2.5% of GDP)
|Top Rate Exempting Couples Making Under ~$400k||102%||83%||65%||
|Top Rate Exempting Couples Making Under ~$250k||90%||75%||60%||56%|
|Top Rate Exempting Couples Making Under ~$150k||80%||68%||56%||53%|
|Top Rate If All Rates Are Raised by an Equal Amount||49%||46%||43%||42%|
Note: Numbers in red fall above the estimated revenue-maximizing level and thus would most likely be impossible to achieve in reality. Some of the higher numbers in black might also not be achievable after accounting for diminishing returns at high rate levels.
Source: CRFB calculations based on estimates from the Congressional Budget Office and Joint Committee on Taxation and the Office of Management & Budget's estimates of the FY13 President's Budget. Estimates for the first option increase rates for the 35 and 39.6 brackets, or for singles and couples above $411,500. Estimates for the second option raise rates on taxable income above roughly $206,000 for individuals and $257,000 for couples. The third option raises rates for taxpayers in the 28 bracket and above, including individuals making over $90,750 and couples making over $151,200. Estimates assume linearity, meaning that a ten point rate increase raises ten times more than a one point increase. In reality, revenue gains would diminish over time and eventually reverse. As a result, these numbers should be considered both very rough and as a maximum estimate of possible revenue gains.
A 2012 report from the Tax Policy Center had basically similar findings. It estimated at the time that reducing debt to 60 percent of GDP by 2035 would require increasing the then-top two tax rates to over 100 percent.
To be sure, the top 1 percent of earners still earn a substantial share of total national income – about 13 percent on an after-tax basis – and further tax increases on this group could help to significantly improve the current debt situation. In addition, many tax preferences go to the top 1 percent and so it would be possible to raise additional revenue from this group from broadening the tax base instead of or in addition to raising the top tax rate. But most likely, these increases would need to be combined with reductions in spending growth, broader tax increases, or some combination of the two to fully address the nation’s fiscal challenges.
Ruling: Largely False
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Update 11/14/15: This post has been significantly updated, to incorporate the rough estimates provided in the table and graph above. The original version of this piece can be found as one of the 16 Myths to Watch For in the 2016 Campaign.