Are Marginal Academics Going Crazy?

The Wall Street Journal’s most popular article today was an editorial by one Professor Michael J. Boskin entitled, “Get Ready for a 70% Marginal Tax Rate,” and it was a doozy. It hearkened back to bygone days at university, when we carelessly tossed haphazardly written bullshit under the professor’s door a minute after the deadline, filled with neat little tricks and techniques designed to give the appearance of substance to whatever flimsy excuse for an argument we had to present that week.

Maybe it’s because Boskin’s article reads like a sophomore homework assignment. “First, as college students learn in Econ 101, higher marginal rates cause real economic harm,” he tells us. (I guess they don’t teach history students the same thing.) Good, we’ve established an axiom. But Professor Boskin, how can we tell?

The combined marginal rate from all taxes is a vital metric, since it heavily influences incentives in the economy—workers and employers, savers and investors base decisions on after-tax returns.

So, the metric for how much higher marginal tax rates are affecting the economy is… the combined marginal rate? Leaving aside the circular logic for the moment, questions arise: how are these tax rates combined, and what is a marginal tax rate, anyway?

The current top federal rate of 35% is scheduled to rise to 39.6% in 2013 (plus one-to-two points from the phase-out of itemized deductions for singles making above $200,000 and couples earning above $250,000). The payroll tax is 12.4% for Social Security (capped at $106,000), and 2.9% for Medicare (no income cap). While the payroll tax is theoretically split between employers and employees, the employers’ share is ultimately shifted to workers in the form of lower wages.

Later, he gives us a sample question, assuming taxes will be broadly increased across the board:

It would be a huge mistake to imagine that the cumulative, cascading burden of many tax rates on the same income will leave the middle class untouched. Take a teacher in California earning $60,000. A current federal rate of 25%, a 9.5% California rate, and 15.3% payroll tax yield a combined income tax rate of 45%.

How does that work? Well, I got out a calculator (you can, too! it’s interactive!) and checked the professor’s math:

60,000×(1−(.095+(.153÷2)) = 49,710

49,710÷60,000 = 82%, or 18% tax rate before federal taxes

Federal taxes take 25% off the rest, leaving 62% of 60,000;

100-62 = a 38% effective tax rate.

How did he get to 45%, I hear you cry? Well, 60,000×(1-(.095+.153))×.75 ends up being a 43.5% effective rate, which is 45% if you round up to the nearest odd number, for some reason. But that would mean Boskin is counting the full payroll tax, half of which is paid by the employer, entirely as lost income in terms of the total tax bill. Why, by those standards, the teacher is actually making $64,590 a year (instead of $60,000 as stated). Also, our teacher takes no deductions whatsoever.

With failures in math and logic, the bigger problem lies in the fact that nowhere does Boskin say what “marginal” tax rates actually are and how they might differ from the other tax rates he yammers on about throughout the piece. Marginal taxes are those paid on the portion of income above a series of cutoffs. So, for example, California’s citizens face a haunting marginal tax rate (on wages only, not capital gains) of 44.1% including state and federal taxes; but that’s the most anyone can pay in taxes anywhere in the state (barring property, sales and other sin taxes, of course). Now I bet you’re wondering, how many people actually pay that rate? Well, here’s a look at income inequality in the United States:

Top Percent Share Of Total Pre-tax Income 1913-2008

Source: Thomas Piketty and Emmanuel Saez, “Income Inequality in the United States, 1913-1998,” Quarterly Journal of Economics, 118(1), 2003. Updated to 2008 at http://emlab.berkeley.edu/users/saez.

The bottom 99% receive between 76-79% of the wages (which is what we’re talking about here) and the same source as the graph above says that in “9 out of 10 households — income [is] below $104,696” and that the average income for these bottom 90% is $30,374 (which includes capital gains). By smoothly transitioning from the injustice of taxing the absolute richest people in the country–a.k.a. the “marginal tax rate”–to the inflated woes of a poor beleaguered California public servant (who is making, one might point out, just about twice the average for the bottom-90% bracket) and threatening Wall Street Journal readers with a projected 70% marginal rate on wages, Boskin has all the bluster he needs to distract from the argument’s essential flaws. One that jumps out at me is the following paragraph:

Nobody—rich, middle-income or poor—can afford to have the economy so burdened. Higher tax rates are the major reason why European per-capita income, according to the Organization for Economic Cooperation and Development, is about 30% lower than in the United States—a permanent difference many times the temporary decline in the recent recession and anemic recovery.

Besides the intentionally misleading wording that leaves the reader to decide whether the OECD specifically blames higher tax rates in Europe for the comparative difference in per-capita income with the U.S., or whether they just operate a website that features statistics for the whole of the European Union (or maybe even all of Europe as a continent), the truth is that the rich can be so burdened. Not only can they be so burdened, but the idea that lower taxes on the extremely wealthy somehow translate into economic benefit for the rest of the economy is flat wrong. You can see exactly how flat I mean:

Average After Tax Income by Income Group 1979-2007
Source: Congressional Budget Office, Average Federal Taxes by Income Group, “Average After-Tax Household Income,” June, 2010.

You see, no matter what the after-tax income of the top marginal earners, since 1979, it hasn’t made one lick of difference in real take-home pay for the rest of us. On the other hand, the wealthiest 5% now make what the wealthiest 1% used to make way back then, and the top 1% themselves are taking in money on what, to the rest of us, looks like a vastly distorted curve.

1979, it turns out, was not only the year Reagan began to return our country to greatness by running for president, but also the year average wages basically stopped growing. Here’s the best part. Baskin acknowledges this problem, and then waves it away as if trying to swat a persistent mosquito:

Some argue the U.S. economy can easily bear higher pre-Reagan tax rates. They point to the 1930s-1950s, when top marginal rates were between 79% and 94%, or the Carter-era 1970s, when the top rate was about 70%. But those rates applied to a much smaller fraction of taxpayers and kicked in at much higher income levels relative to today.

There were also greater opportunities for sheltering income from the income tax. The lower marginal tax rates in the 1980s led to the best quarter-century of economic performance in American history. Large increases in tax rates are a recipe for economic stagnation, socioeconomic ossification, and the loss of American global competitiveness and leadership.

Back to the history books: in the 50′s and 60′s, when we were doing the exact opposite of “economic stagnation, socioeconomic ossification, and the loss of American global competitiveness and leadership,” marginal tax rates were between 94% and 70%. Not to mention the entire article is a long strawman directed at imagined increases in taxation connected to the weight of our deficit, $1 trillion of which were awarded as tax breaks to the wealthy in the last 10 years–and look how well that turned out.

So Boskin fudges the facts and the figures and the history and drips a little Milton Friedman blood on the altar of no-taxes. Who is this guy, anyway? Only last year, Boskin issued a screed on the same WSJ editorial page savaging the totalitarian impulse to destroy the truth with faulty numbers:

Politicians and scientists who don’t like what their data show lately have simply taken to changing the numbers. They believe that their end—socialism, global climate regulation, health-care legislation, repudiating debt commitments, la gloire française—justifies throwing out even minimum standards of accuracy. It appears that no numbers are immune: not GDP, not inflation, not budget, not job or cost estimates, and certainly not temperature. A CEO or CFO issuing such massaged numbers would land in jail.

Well, at least his motives are purely scientific–Boskin is, after all, a humble Stanford economics professor. It’s not like he’s in that rareified top echelon of earners who are actually paying the top marginal tax rate, he’s just a neoclassical economist with a real ideological fervor, right? Wrong.

Boskin happens to be a member of Exxon Mobil’s board of directors and has been for over 15 years. He also sits on the boards of Oracle, Japan’s Shinsei Bank, and European telecom giant Vodafone. He also happens to be the Friedman chair and a fellow at conservative think-tank The Hoover Institution, named after one of America’s favorite presidents (definitely in the top 100). So, this guy knows a thing or two about corporate number-crunching. And, history!

In Argentina, President Néstor Kirchner didn’t like the political and budget hits from high inflation. After a politicized personnel purge in 2002, he changed the inflation measures. Conveniently, the new numbers showed lower inflation and therefore lower interest payments on the government’s inflation-linked bonds. Investor and public confidence in the objectivity of the inflation statistics evaporated. His wife and successor Cristina Kirchner is now trying to grab the central bank’s reserves to pay for the country’s debt.

Most interestingly, Boskin was once head of the Boskin Commission, which convinced the government that… here, I’ll just let Wikipedia explain, it’s easier:

Its final report, titled “Toward A More Accurate Measure Of The Cost Of Living” and issued on December 4, 1996, concluded that the CPI [Consumer Price Index] overstated inflation by about 1.1 percentage points per year in 1996 and about 1.3 percentage points prior to 1996.

The report was important because inflation, as calculated by the Bureau of Labor Statistics, is used to index the annual payment increases in Social Security and other retirement and compensation programs. This implied that the federal budget had increased by more than it should have, and that projections of future budget deficits were too large. The original report calculated that the overstatement of inflation would add $148 billion to the deficit and $691 billion to the national debt by 2006.

I guess Stanford’s Irony Department is really great.


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