Paul Krugman’s Error Over Ocasio Cortez And The 70 – 80% Top Income Tax Rate

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It’s always necessary to distinguish between Paul Krugman the exceptionally good economist and Paul Krugman the left leaning columnist for the New York Times as with this little story about Alexandria Ocasio Cortez and the idea of 70 to 80% top income tax rates. For as so often happens the columnist is not making the careful distinctions that the economist would. Or, if we were feeling a little more uncharitable, that the politically driven columnist wishes to shout “Yay My Side!” while ignoring those distinctions that the economist would make. This is something that makes economists sad for the the Paul Krugman who does the economics is truly excellent at doing so.

This is apparent here in talking about Ocasio Cortez:

The controversy of the moment involves AOC’s advocacy of a tax rate of 70-80 percent on very high incomes, which is obviously crazy, right? I mean, who thinks that makes sense? Only ignorant people like … um, Peter Diamond, Nobel laureate in economics and arguably the world’s leading expert on public finance. (Although Republicans blocked him from an appointment to the Federal Reserve Board with claims that he was unqualified. Really.) And it’s a policy nobody has ever implemented, aside from … the United States, for 35 years after World War II — including the most successful period of economic growth in our history. To be more specific, Diamond, in work with Emmanuel Saez — one of our leading experts on inequality — estimated the optimal top tax rate to be 73 percent. Some put it higher: Christina Romer, top macroeconomist and former head of President Obama’s Council of Economic Advisers, estimates it at more than 80 percent.

Well, no, Peter Diamond doesn’t think that. The Diamond and Saez paper is here and the important point to understand is this:

Thus, the distinction
between real responses and tax avoidance responses is critical for tax policy. As an
illustration using the different elasticity estimates of Gruber and Saez (2002) for high
income earners mentioned above, the optimal top tax rate using the current taxable
income base (and ignoring tax externalities) would be *=1/(1+1.5 x 0.57)=54 percent
while the optimal top tax rate using a broader income base with no deductions would be
*=1/(1+1.5 x 0.17)=80 percent. Taking as fixed state and payroll tax rates, such rates
correspond to top federal income tax rates equal to 48 and 76 percent, respectively.

The really important part being “no deductions”. This needs to be read widely. They mean that the existence of a different capital gains tax rate is a deduction – because it is possible to move income into capital gains. And so on – no deductions means the near abolishment of near all of the tax code other than just that top rate.

If we have a system with deductions – and it’s near impossible to imagine one without at least some say, for everyone except Americans, just leaving the country – the optimal top rate becomes that 54% on incomes, something that’s already achieved in most Blue States when local income taxation is included.

And the thing is the economist Paul Krugman would be very keen on making such distinctions. The columnist not so much. Pity.