Taxes and the Top Percentile Myth

January 4, 2011

Arguments by the left for retaliatory tax penalties begin with estimates by economists Thomas Piketty of the Paris School of Economics and Emmanuel Saez of the University of California, Berkeley, that the wealthiest 1 percent of U.S. households now take home more than 20 percent of all household income.  This estimate suffers two obvious and fatal flaws, says Alan Reynolds, senior fellow with the Cato Institute.

  • The first is that the "more than 20 percent" figure does not refer to "take home" income at all -- it refers to income before taxes (including capital gains) as a share of income before transfers, which tells us nothing about whether the top percentile pays too much or too little in income taxes.
  • A second fatal flaw is that the large share of income reported by the upper 1 percent is largely a consequence of lower tax rates.

Also, according to a 2008 study of 24 leading economies by the Organization of Economic Cooperation and Development (OECD):

  • Taxation is most progressively distributed in the United States, probably reflecting the greater role played by refundable tax credits, such as the Earned Income Tax Credit and the Child Tax Credit.
  • The ratio of taxes paid to income received by the top 10 percent is by far the highest in the United States, at 1.35, compared to 1.1 for France, 1.07 for Germany, 1.01 for Japan and 1.0 for Sweden.

The Piketty and Saez estimates are irrelevant to questions about income distribution because they exclude taxes and transfers.  What those figures do show, however, is that if tax rates on high incomes, capital gains and dividends were increased in 2013, the top 1 percent's reported share of before-tax income would indeed go way down, says Reynolds.

  • That would be partly because of reduced effort, investment and entrepreneurship.
  • Once higher tax rates cause the top 1 percent to report less income, then top taxpayers would likely pay a much smaller share of taxes, just as they do in, say, France or Sweden.

Source:  Alan Reynolds, "Taxes and the Top Percentile Myth," Cato Institute, December 23, 2010.

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