From the Desk of Professor Ernie Goss
Punishing Success by Raising Taxes:
Biden’s Bite to Support Government Expansion
President Biden has promised to raise taxes on high income individuals to fund his planned rapid decade-long expansion in federal spending. His approach calls for raising the top income tax rate from 37% to 39.6%, limiting deductions for top earners, and boosting the long-term capital gains tax rate for high earners from 20% to 39.6%.
Table 1 below lists the 10 states with current highest income tax rates on additional income. As presented, a California high wage earner, or self-employed, keeps only $35.85 of every $100 of additional income. Importantly, these rates do not account for other taxes paid primarily by higher income individuals such as capital gains taxes, and do not consider Biden’s proposed cap on deductions for high income earners. The rates do include Medicare, and Social Security taxes.
Even before the Biden Bite, the top 5% of earners pay approximately 58% of federal income taxes. Likewise, the increase is ill-timed hitting earners in an economic downturn (i.e. a reverse stimulus). The Keynesians should be properly outraged, but don’t count on witnessing it.
In addition to funding a plethora of new government programs, proponents of the Biden Bite argue that these tax hikes will reduce income inequality as measured by the Gini Coefficient. The Gini Coefficient measures income inequality with the coefficient varying from zero (least income inequality) to 1.00 (maximum income equality).
Table 2 lists the ten states experiencing the greatest degree on income inequality. Four states with the highest income inequality are ranked in the top 15 states in terms of income tax rates. Calculating the correlation between top tax rates and the Gini Coefficients for the 50 states and D.C. indicates only a slight association between tax rates and the Gini Coefficients. However, the association is opposite to that argued by the Biden proponents. That is, states with higher tax rates on higher earners experience greater income inequality, not less.
This essay is based on state income tax data indicating that increasing the tax rate on higher income has not and will not reduce income inequality, and in fact may increase income inequality.
Taxing better educated, higher earners will instead further burden high earners which discourages initiative, reduces the motivation to improve human capital via education, and incentivizes tax avoidance and/or tax evasion. Furthermore, raising taxes at this time, offsets some of the positive impacts of stimulating the economy with higher consumer spending fueled by Stimulus I and II.
