Should income tax rates climb to 70 percent?

Newly elected politicians sometimes bring fresh ideas to the table.  In the case of US Rep. Alexandria Ocasio-Cortez (D-NY), we have a stale idea recycled -- raising income tax rates to 70 percent.  The top federal marginal tax rate in the US used to be 90 percent in the 1950s and early 1960s and remained at 70 percent through the early 1980s.  Ocasio-Cortez is pushing for the 70 percent rate to kick in at personal income above $10 million and would use the funds to pay for a Green New Deal.

As always, you will find some economists in support (see this summary by Matthew Yglesias) and others who are highly critical (see this Bloomberg column by Tyler Cowen and John Cochrane's blog).  The supporters back their arguments up with theoretical frameworks containing curious assumptions.  One has to do with diminishing marginal utility: an extra thousand dollars for Warren Buffett does nothing for Warren but can be life-changing for a homeless person.  (But do you trust the federal government to make these calculations?  Maybe another Congress  in 2030 decides the 70% rate should kick in at $100,000?)  Other key assumptions: 100% tax compliance and near-zero labor supply elasticities.

Eventually all income tax rates are going to have to go up because (1) the US budget deficit is not in a sustainable position and (2) the required compromise will have to include revenue enhancement along with expenditure reduction.  Although a 70 percent rate might look initially attractive from a  revenue generation standpoint, people make choices about how they get paid (cash versus benefits), how many hours they work and what professions they enter.  I doubt NC State would have as many MBA students as it does now if the top tax rate were above 50 percent.

Incentives matter: the case of Medicaid

A critical challenge in designing income maintenance programs is the tradeoff between benefit generosity and the incentive to work.  In a recent WP column, Catherine Rampell compares work incentives in the states where Medicaid has expanded under Obamacare to the states (including North Carolina) which have kept the pre-Obamacare system.  In the 19 states that have rejected the Medicaid expansion under Obamacare, if a working parent earns more than 61% of the poverty line ($12,300 for a family of three), then that household loses ALL of their Medicaid benefits.

Rampell suggests that a sliding scale be used instead, so that as the parent starts earning more than $12.3k, the family loses a fraction of their Medicaid benefits as opposed to the whole amount.  The current practice in effect penalizes work effort that generates more that $12.3k, locking millions of households into poverty.

Now there is a catch -- a sliding scale means that more families become eligible for Medicaid.  Benefits might not be entirely phased out until the parent earns $25k or more.  But as more parents work more hours, extra revenue gets generated because (1) their families rely less on Medicaid and other income maintenance programs and (2) they pay more income and payroll taxes.

I expect this to be a big issue in the NC gubernatorial contest this year.  Gov. McCrory famously turned down federal funds that would have provided significant increases in health care for poor North Carolina families.  They have a big incentive to remember that on Nov. 8.