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Script:
Can taxing the rich fix the budget deficit? Whenever debates arise over how to fix the soaring federal debt, many on the political left—and even some on the populist right—invariably say “easy, just tax the rich.”
But is it really that easy?
Can those budget deficits of nearly $2 trillion headed toward $4 trillion annually within a decade can simply be closed by higher taxes on the wealthy and corporations?
The answer is an emphatic “no” -- and it’s not a question of ideology, it’s not about picking winners and losers.
It’s just math.
To be clear, we can tax the rich more. And in fact, taxing the rich can absolutely be part of a broader deficit “grand deal” where all taxes and spending are up for debate. But it could only ever be a modest part of a grand deal, because the potential revenue available from taxing the rich can close only a small portion of our nearly unfathomable deficits.
Let’s begin with an extreme example -- America has about 800 billionaires. Let’s imagine we seized every single dollar of their wealth -- every home, property, business, investment, car, and yacht … all, right down to their kids’ teddy bears -- and we sold it all for full market value.
That would raise enough revenue to finance the federal government for 9 months. Not 9 months out of every year -- 9 months one time. Then, with no billionaires left to pillage, It’s gone.
Oh, and so is your 401(k), because most of that wealth would’ve been liquidated out of the stock market.
Even taxing million-dollar earners at 100% marginal tax rates wouldn’t balance the long-term budget -- even if each of those taxpayers continued working optimally for zero net pay.
Chart - https://media4.manhattan-institute.org/wp-content/uploads/Budget-Chart-Book-2024.pdf#page=80
Only slightly more realistically, Imagine that President Bernie Sanders gets to implement his dream tax proposal. We’re talking his proposal of federal income tax rates as high as 52%, an uncapped 15.3% payroll tax on all wages, and capital gains tax rates of 62% -- plus the state tax rates on top of those. And we’d also hit corporations with a world-leading 35% corporate tax rate that includes all multi-national income, a wealth tax rate as high as 8%, an estate tax rate as high as 77%, new financial transaction taxes, and… that’s only the beginning of countless other surtaxes.
Basically, income, capital gains, business, wealth, and estate tax rates would all be set at the highest rate in the developed world. And the total new revenues would be… Approximately 1.5% of GDP.
That is a lot of money. But it’s not enough to close more than a fraction of a current-policy budget deficit heading toward 8% of GDP in the next decade.
And even those revenue figures implausibly assume that people and corporations would continue working, saving, and investing despite combined federal and state marginal tax rates on labor and investment that would approach 80% to 100%.
Actual tax revenues would likely increase by about 1.5% of GDP.
Two years ago I ran a model that set every upper-income and corporate tax policy at its revenue-maximizing level without regard to economic damage. It showed roughly 1.5% of GDP in new revenues and much slower economic growth. It’s a terrible tradeoff.
The mathematical reality is that there just aren’t enough millionaires, billionaires, and undertaxed corporations to close a 30-year budget deficit of between $115 trillion and $180 trillion, depending on the baseline we use.
It just isn’t possible to finance annual deficits heading to $4 trillion in a decade and 14% of GDP over the next 30 years on the backs of corporations and only 5% of American families.
There just are not enough super-rich people to pay for the other 300 million of us. And most of the available tax base resides in that large middle class.
The surprising secret no one seems to talk about is that the tax code is already extraordinarily progressive -- it’s the most progressive tax code in the OECD. And it’s grown radically more progressive over the past 40 years.
The top-earning 20% now pays 69% of all federal taxes, and the top 1% currently pay 25% of all federal taxes. By contrast, the bottom-earning 60% of Americans -- that’s 3 out of 5 taxpayers -- pay just 13% of total federal taxes, including a combined negative income tax.
Last year the federal government funded 263 days of spending by taxes instead of borrowing. Of that, the top-earning 20% funded the government for 201 days, or nearly 7 months. The next 20%? 41 days. And the bottom-earning 60% of Americans -- which means most of the US population including the median-earners -- funded the federal government for just 21 days of the year.
That level of tax progressivity might not be a bad thing. But most of the nation’s total income comes from families earning under $400,000. And their dramatically lower current tax rates mean that the large majority of the available remaining tax base resides within the tens of millions of these families.
No one likes the idea of raising middle class taxes, but there’s only so much revenue to raise from the wealthy.
Now, I know what many of you are thinking. How can this be true? What about those old 91% tax rates from the 1950s? What about Europe’s tax-the-rich social democracies? What about those millionaires and corporations that paid nothing last year? Ok, let’s take these one at a time.
Start with those old 91% income tax rates in the 1950s. Those income tax systems averaged only 7.2% of GDP in federal income tax revenues. As the top tax bracket fell to 70% in the 60’s and 70’s, income tax revenues actually rose to around 7.8% of GDP. And since all the dramatic reductions of the top income tax rates starting in 1981, federal income tax revenues have averaged 8.1% of GDP.
So, Washington collects more income tax revenues as a share of GDP today with a top tax bracket of 37% than it collected in the 1950s with a 91% tax bracket. In fact, since 1950, the correlation between the highest income tax bracket and revenues as a share of the economy is -0.25%, meaning that higher top tax rates are correlated with lower income tax revenues.
How can that be? Well, it turns out that the highest income tax brackets don’t tell us much about the total income tax revenues. What matters more are the income thresholds for every tax bracket, the amount of tax preferences and tax deductions, whether the tax system encourages tax avoidance and tax evasion, and—most important—broader economic growth rates. If you want more tax revenues, look there.
You see, almost no one actually paid those old 91% tax rates, which kicked in at today’s equivalent of a $4.1 million annual income. In 1961, that was just 446 families, and it raised just 0.1% of all income tax revenues. In fact, all of the tax brackets between 52% and 91% collectively produced just 1% more income tax revenue than if we had capped those tax brackets at 50%. Those tax brackets won’t even pay for 2 days a year of federal spending.
If you want 91% tax rates, go ahead -- but don’t point to 1950s America as proof that they work.
But surely Europe has it figured out! They know how to fund large welfare states on the backs of the rich!
Right? Wrong again. They do it by taxing the middle class.
Europe just isn’t the caricature Americans imagined decades ago. The average OECD nation does collect 7.5% of GDP more in tax revenues than the US across all levels of government. And virtually that entire gap is explained by every other OECD nation assessing a value-added tax -- essentially, a sales tax, as high as 27%. That typically raises 7.2% of GDP, so not counting the VAT, US and European tax revenues are nearly equal.
Even the social democratic Scandinavian countries that collect 14% of GDP more than the US do it almost entirely from their VAT and higher payroll taxes -- which come from everyone, not just the rich.
America’s top tax brackets for income, capital gains, corporate, and estate taxes are actually all slightly higher than the typical OECD nations when merging all levels of government. We’ve got the most progressive tax system in the OECD because we tax the rich at similar rates as those other countries, but we tax the middle and lower classes dramatically less than they do.
The American middle class deals with far lower payroll and income tax rates -- so if you want America to tax like Europe, then our middle class is going to get the nastiest surprise of its life.
That third common counter-argument is to blame budget deficits on that billionaire or corporation that reportedly paid no taxes last year.
Every year we get reports of a handful of corporations that paid little to no taxes last year, or those ‘Warren Buffet pays less tax than his secretary’ stories. The corporate examples are often the result of shifting income and taxes from one year to the next, which means any real analysis should examine a corporation’s taxes over a period of several years.
And the corporations paying low taxes over many years are typically either earning most of their income abroad and paying foreign taxes, or taking advantage of tax breaks for business investment and R&D that politicians create to encourage those activities.
Either way, eliminating those tax breaks and taxing these companies more could raise perhaps $100 billion a year. That’s real money -- but it’s not a game-changer in the context of those $4 trillion annual deficits we’re heading toward. And, of course, we’d lose the business investment and job creation that comes from those incentives.
With rich individuals, it’s absolutely true that much of their income is shifted into capital gains or borrowing against their wealth. The capital gains will eventually be taxed when it’s sold, unless they carry it through to death. Ensuring that capital gains would be taxed at death or that rich people can no longer easily borrow tax-free against their wealth are possible reforms -- but they wouldn’t raise revenue of any significance to our deficits.
None of this means we shouldn’t tax the rich more. Fixing a ruinous deficit requires putting everything on the table, including higher taxes on the rich.
Personally, I support closing the loophole that permanently exempts capital gains from taxation if they’re held until death. And I also support dramatically scaling back upper income and corporate tax loopholes, and fully funding IRS audits against high earning and corporate tax cheats.
But we’ve got to acknowledge the mathematical reality that our budget deficits have grown so massive that “tax the rich” policies can’t close more than a tiny fraction of them. And, also, that much of Europe long ago learned the hard way that going overboard on tax the rich policies can backfire on the economy. That’s why their “tax the rich” policies have moved so much closer to ours. A slow-growing economy can’t produce enough revenues to cut its deficit no matter how high its tax rates are. We need higher revenues in the least economically-damaging way possible.
And yes, if we want to stabilize the debt, that means middle class taxes will have to rise -- as well as putting all federal spending on the chopping block, especially including Social Security, Medicare, and defense.
The problem, of course, is that neither political party is suicidal enough to tell middle class voters that their taxes and benefits must also contribute heavily to reining in runaway deficits. So we comfort ourselves with the wishful thinking that millionaires and billionaires can take the entire burden off our hands. But, beyond the empty rhetoric, you will never see a specific, fully-scored proposal to eliminate most of the long-term deficit by taxing the rich, because mathematically, it’s just not possible.