WINNING ISN’T EVERYTHING61
What is true of professional athletes seems to be true of rich people in general.
The question of taxes on rich people took center stage in the political discourse in the United States at the end of 2018.
With Alexandria Ocasio-Cortez’s proposal of a top marginal income tax above 70 percent and Elizabeth Warren’s call to establish a progressive wealth tax, tax policy became one of the core issues at stake for the 2020 presidential election.Given the longstanding importance of income taxation as a policy issue, it is no surprise there are many studies that look at whether people stop working when their income taxes increase. The authoritative review of the literature by Emmanuel Saez and his colleagues concludes that real work effort does not respond to top tax rates, although effort to evade or avoid taxes does.62 For example, the Reagan tax cut of 1986 led to a large onetime increase in personal taxable income, which faded quickly. This suggests the increase in taxable income was mainly people bringing their previously hidden incomes into the (now friendlier) tax net rather than an increase in earnings and hence effort. In countries where there are no easy loopholes because taxes apply to all income (with no differential treatment for investment income, labor income, or “fees for being a real estate agent”), taxable income (and therefore the underlying real effort) is insensitive to taxation.
This should make sense. For top athletes, as Vince Lombardi is reputed to have said, “Winning isn’t everything, it’s the only thing.” They are not going to do less than their best because the tax rate just went up. The same probably goes for top CEOs and aspiring top CEOs.
What about the idea that the best firms want the best managers and are willing to pay top dollar for them? Would they be able to do that if taxes were high? The answer is yes.
The argument that the best CEO will go wherever he makes the most money works no differently when the government takes 70 percent of the money. The highest-paid job is still the highest-paid job, as long as the tax rate is the same in all firms.However, high top marginal tax rates may also reduce the lure of the most lucrative, but not necessarily the most socially useful, professions, such as finance. Without the attraction of huge take-home pay, aspiring top managers may prefer to go where they will be the most productive, not where they will make the most money. A silver lining of the 2008 crisis is that it reduced the appeal of the financial sector for the brightest minds; a study of career choices of MIT graduates found those who graduated in 2009 were 45 percent less likely to choose finance than those who graduated between 2006 and 2008.63 This may lead to a better allocation of talent, and to the extent finance’s salary levels infect every other sector, it could further reduce income inequality.
All in all, therefore, it seems to us that high marginal income tax rates, applied only to very high incomes, are a perfectly sensible way to limit the explosion of top income inequality. They would not be extortionary, since very few people will end up paying them; top managers will simply not get these kinds of income anymore. And from all we see, they won’t discourage anybody to work as hard as they can. To the extent they affect people’s choice of career, it will likely be in a positive direction. This is not to deny the importance of structural economic changes, which have made it increasingly difficult for those with low education to succeed, generating an increase in inequality even within the remaining 99 percent.64 Addressing this issue will call for other complementary approaches. But we might as well begin by eliminating the ur-super-rich (which really means, in case you feel sorry for them, turning them to merely super rich).