How will Americans escape the coming 70-80 percent income tax rates?

“The Economics of Soaking the Rich: What does Alexandria Ocasio-Cortez know about tax policy? A lot.” (Paul Krugman, NYT):

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. … 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.

As I said, Diamond and Saez put the optimal rate at 73 percent, Romer at over 80 percent — which is consistent with what AOC said.

What we see [from a displayed chart] is that America used to have very high tax rates on the rich — higher even than those AOC is proposing — and did just fine. Since then tax rates have come way down, and if anything the economy has done less well.

Which brings me back to AOC, and the constant effort to portray her as flaky and ignorant. Well, on the tax issue she’s just saying what good economists say

Back in the glory days to which Krugman refers, Americans escaped the high ordinary income tax rates by converting what looked like ordinary income into capital gains, taxed at roughly the same rate then as now. See https://philip.greenspun.com/blog/2016/05/06/eisenhower-era-tax-avoidance-strategies-from-eisenhower/

Let’s assume that the Democrats will regain control over the U.S. at some point and that there is a good chance that the young and charismatic folks such as AOC will be the leaders. We will then have the tax rates that they’re currently proposing.

What would be the impact on a successful Californian, for example? The current tax rate is 39.6 percent federal plus 13.3 percent state. So the earner can spend 47 cents of each gross dollar. With an 80 percent federal rate, the after-tax benefit of earning one extra dollar would be 7 cents. This is an 85-percent pay cut for the rich Californian, which should provide some motivation to act.

Question for today: How will Americans adapt?

The world is very different from what it was in the high-tax heyday. The economy is a lot more global. It is possible to pay 10 percent on income in the UK (see https://philip.greenspun.com/blog/2019/01/02/move-to-the-uk-if-youre-an-entrepreneur-10-percent-capital-gains-tax/ ) or 20ish percent in Estonia or Singapore. Americans can take advantage of foreign corporate tax rates by starting enterprises overseas, but individual income tax rates are available, however, only to those who renounce U.S. citizenship, which can be expensive and challenging. (Also, for anyone living in the UK, it is quite easy for a family court plaintiff to impose a 50 percent tax on assets after a two-year marriage! See Real World Divorce.)

We have corporate tax rates of about 26 percent now (Tax Foundation). Could it be that our most productive citizens will simply start corporations and accumulate profits inside the corporate shell indefinitely, Warren Buffett style, thus deferring taxes for decades?

Will our most productive citizens move to Puerto Rico for 183 days per year? (see Forbes for how Americans can become mostly tax-exempt and GQ for the lifestyle report)

Will every rich family set up non-profit orgs like the Clinton Foundation and run all of their Gulfstream charter and parties in Switzerland and Australia through the foundation?

Given our spectacular debt-to-GDP ratio, the fondness of the American voter for a command-and-control centrally planned economy, and the growing number of voters who aren’t subject to income tax (since they are on welfare or otherwise have low income), high future individual tax rates do seem plausible.

Or will productive Americans just decide to pay the exit tax and renounce their citizenship, following Eduardo Saverin‘s example?

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13 thoughts on “How will Americans escape the coming 70-80 percent income tax rates?

  1. Won’t America be nicer when all the folks who’s singular priority in life is making as much money as possible while paying as little tax, flee? I don’t understand the thinking that tinkering with the tax rates of 1-2% of the population will have some catastrophic effect. Doesn’t it stand to reason that the income of the other 98-99% of people, and accelerating income inequality, is far more important to the health of our economy? The reason successful businesses are started and operated in the US isn’t because we have the lowest taxes. There will always, always be places with lower tax rates. Could Amazon or Microsoft have been created in Albania? No, of course not. What are some examples of mind boggling innovation coming out of Singapore with their attractive tax rates? Tax rates are one factor, but there are many more reasons why people wouldn’t flee. The sky will not fall. I’m still waiting for the huge boon to our economy that the trickle-downers promised would result from slashing our corporate tax rates!

  2. Senorpablo: If the top 1-2% renounce and move, I think the U.S. could well be “nicer,” at least from the point of view of people who are prone to envy. Having super rich neighbors makes people less happy (yet we have a bureaucracy to allocate free Manhattan apartments to those with low income so that they can live in poverty right next to the richest people in the U.S. rather than taking the $2 million cash value of their free apartment and being rich almost anywhere else in the U.S.). But, on the other hand, we live in a global world. People who are envious can be envious seeing someone in China, Ireland, or Singapore driving to the airport in a Ferrari, boarding a Gulfstream G650, sipping Chateau Margaux, etc.

    Why does the tax rate on the top 1% matter? They paid 39 percent of all income tax in 2015 (maybe the most recent year available; see https://taxfoundation.org/summary-federal-income-tax-data-2017/ ). So if the behavior of the top 1% changes, nearly 39 percent of government tax revenue is at risk.

    Singapore with its 5.6 million people has not produced as many innovations as the U.S. with 330 million? Wouldn’t a more apt comparison be to a U.S. state with a similar population, e.g., Minnesota, Colorado, or Wisconsin?

    In any case, keep in mind that a non-citizen can start and own a business in the U.S. without paying U.S. individual income tax rates. Eduardo Saverin is a great example of that. If the dividend checks from a U.S. company go back to a shareholder in Singapore, the Singapore resident and/or citizen will pay taxes at the Singapore rate. As noted in the original posting, a U.S. citizen and shareholder can even stay in the U.S. and escape an 80 percent tax rate (by moving to Puerto Rico).

    • Envy is the most pathetic sin because at least the others, gluttony, sloth, lust, make you happier, at least for the moment.

  3. As a US citizen but non US resident it is wildly annoying to pay taxes to two different governments. Yes, it’s true, I get some deductions for living outside the US but you still have somewhat duplicate record keeping and, of course, the whole (paid) filing process for the US. And, of course, the schedules do not line up so while my 2017 Swiss taxes were closed out in mid 2018, I’m still waiting for my 2017 taxes to be filed with the US.

    To get rid of this double filing I would first have to get another citizenship (non-trivial) and then go through a longish process to actually renounce my US citizenship. Plus depending on your financial situation there is quite the impressive exit tax, payable now, in cash.

  4. The whole debate is distorted by characterizing incremental changes as wild upheavals. Nobody’s tax rate is jumping to 70 percent. Income taxes are almost irrelevant in a country where debt is driving both public and private finance. We should be much more concerned about interest rates than tax rates. Ten years of zero-ish interest is a much more radical policy than who pays what income tax. Zero rates have radically favored capital, now mention of some tiddly adjustments to taxes brings howls of “fake fear” from capitalists.

  5. the other Donald: A basic interest rate (such as LIBOR or the Fed discount rate) that is lower than the inflation rate has “radically favored capital”?

    For someone with new capital to invest, wouldn’t it be better to get a higher real interest rate (after subtracting inflation) than a lower one?

    You could assume that wealthy people already own common stocks and therefore they will benefit when the P/E ratio rises in response to lower rates, but lower U.S. rates devalue the U.S. dollar so measured against a basket of world currencies or assets the stocks might end up being worth the same (and, of course, they will simply go back down when rates are raised again, if you model stocks as being valued for their future profit stream).

    There is more capital in bonds than in stocks (see http://www.theifod.com/which-is-bigger-the-stock-market-or-bond-market/ for the total sizes; $40 trillion in U.S. bonds versus $27 trillion in U.S. stocks as of 2016). The correlation between the price of an existing bond and interest rates is stronger than for stocks, so the “capital” in bonds got a big boost when interest rates were dropped to near zero, but anyone looking for a place to invest new capital (e.g., after an existing bond matured) had trouble finding a yield higher than inflation. And, as with stocks, for someone who just held the bond it would go up and then come back down when the interest rates were returned to normal (and, measured in terms of “How many U.S. bonds will it take to buy an apartment in London or Paris” the answer may not change as U.S. rates are adjusted).

    http://time.com/money/3749580/higher-rates-winners-losers/ tries to do this analysis (from 2015)/

    (Separately, pushing the Federal income tax rate up to 80 percent (don’t forget to add California’s 13.3 percent rate to this for a total marginal rate of 93.3) is a “tiddly adjustment” that won’t change anyone’s behavior? The successful Californian who is currently keeping $5 million/year in spending power on a $10 million income will be scaled back to about $700,000 in after-tax spending power (or down to $0 if the local plaintiffs play their cards right; see http://www.realworlddivorce.com/California ). That’s an 85 percent reduction in spending power. You don’t think that person would at least consider a move to Puerto Rico for 183 days per year?)

    U.S. government policy for the past 10 years has unquestionably favored homeowners and banks. Then there are subsidies for at least moderately rich people who buy Teslas (favoring them over drivers of 10-year-old Toyotas). But I am not sure that “capital” in general is given a huge boost when the basic return to capital is set to be super low.

  6. Bruce: I feel for you! I do wish that governments would make taxation a lot simpler and more aligned with services provided. With a reasonably efficient government, you’d think that it would be possible to fund it all from property tax, VAT, and a congestion tax for using the road system (typically government-owned). So the property owner writes one check per year and the typical consumer never sees the taxation process. Maybe this is an unrealistic dream since hardly any countries actually do anything like this (exceptions are oil-rich nations and Bahamas, Monaco, Caymans, etc.).

    I think the Feds set it up right for taxing private aviation. There is a tax per gallon of fuel sold that gets fed back into building and maintaining the infrastructure. So the operator of a Cessna wouldn’t have to engage in additional transactions to comply with the tax code. Eisenhower, of course, set up a similar fuel tax to pay for the Interstate highway system.

    Rich people do spend money like crazy on property, goods, and services, so I think a federal property tax could raise significant money, including from businesses. Look at Apple, for example. They have escaped taxation on their profit by piping it through Ireland into offshore trusts. But it wouldn’t be so easy for them to move all of their buildings and employees offshore. https://oceandrive.com/heres-where-the-world-billionaires-are-buying-homes-in-miami talks about billion-dollar condo buildings in Miami. The residents have escaped state income tax in NY, NJ, CT, or CA, but it wouldn’t be easy for them to escape a higher property tax. (And a congestion tax on using Miami roads would raise $billions; the federally-funded Interstates there are jammed for 12 hours per day.)

    Every minute that Americans spend complying with our byzantine tax code or, worse, figuring out how to work around it, is a minute that they could have spent working and growing the economy.

  7. > Why does the tax rate on the top 1% matter? They paid 39 percent of all income tax in 2015 (maybe the most recent year available; see https://taxfoundation.org/summary-federal-income-tax-data-2017/ ).

    See appendix item 3. This only accounts for individual income tax. Does not include payroll tax.

    “About 48 percent of federal revenue comes from individual income taxes, 9 percent from corporate income taxes, and another 35 percent from payroll taxes that fund social insurance programs”
    https://www.taxpolicycenter.org/briefing-book/what-are-sources-revenue-federal-government

    Of course, employers and employees “split” the cost of payroll taxes. So the tax burden on the employee is actually double what they think they “pay.” The effective payroll tax rate is highly regressive (https://en.wikipedia.org/wiki/Federal_Insurance_Contributions_Act_tax#/media/File:Effective_Payroll_Tax_rate_for_Different_Income_Percentiles_(2010).gif), while the individual income tax is highly progressive. It’s tough to find numbers for the distribution of payroll taxes paid by income, but maybe it evens out? (Payroll taxes do max out).

    > So if the behavior of the top 1% changes, nearly 39 percent of government tax revenue is at risk.

    Not really. More like 39% of 48% — about 19% of revenues. And it’s even less than that, since it’s (as proposed by AOC) a marginal tax rate applied only on the fraction of income exceeding $10M. About $245B out of $405B according to this (https://www.washingtonpost.com/business/2019/01/05/ocasio-cortez-wants-higher-taxes-very-rich-americans-heres-how-much-money-could-that-raise/), or 60%. So, it’s 60% of 39% of 48% — about 11% would be at risk.

    In any case, the US has trouble extracting much more than 19% of GDP for any amount of time (https://reason.com/archives/2011/02/14/the-19-percent-solution). So even if taxes are successfully raised on high-earners, it seems it won’t be long until it gets reversed yet again. Unless we go full Venezuela.

    > Maybe this is an unrealistic dream since hardly any countries actually do anything like this (exceptions are oil-rich nations

    Aren’t we the oil-richest nation now? (https://www.forbes.com/sites/davidblackmon/2017/08/17/gilmer-we-should-view-the-permian-basin-as-a-permanent-resource/)

    You are not alone in your property tax dream
    (https://www.economist.com/free-exchange/2015/04/01/why-henry-george-had-a-point).

  8. Brian: Thanks for the links and analysis.

    Do the regressive and progressive taxes even out here in the U.S.? I have seen some analyses that says that they more or less do.

    Nit: I don’t think that we can be considered “oil-rich” due to our large population. Let’s say that Permian Basin oil article you linked to is right and the oil is worth $20 trillion net (after extraction costs) over the next 50 or 100 years. Assume that the U.S. population grows to 400 million. That’s only $50,000 per resident total over those 50-100 years (about $1,000 per year). Saudi Arabia got $567 billion in oil export revenue in 2017. Divide by a population of 33 million and it is over $17,000 per year per person. So we would need 17 Permian Basins to become as “oil-rich” per capita as Saudi Arabia.

    Let’s see if Thomas Friedman, married to the daughter of a real estate billionaire, will sign up to that “tax all of the misgotten real estate wealth” idea from the Economist article you cite!

  9. Phil, as is always the case with people who throw the statistic around hoping to astound with sheer magnitude, you convieniently leave out the fact that those folks who contribute 39% of taxe revenue also control 40% of the total wealth. I hadn’t really considered envy. I was thinking more along the lines of people who go around buying legacy drug companies and raising the price 5000% because they can. Or, the many geniuses across many industries that cooked up the housing crisis. I wish those folks would go elsewhere in search of lower taxes and wreck some other society.

  10. philg, a great deal of your response is remarks on things I didn’t say (you said “pushing the federal rate up to 80 percent” – I said “nobody’s tax rate is going to 70 percent” because realistically any increases will be “tiddly”. Ten years of zero rates is a very significant period (and it really happened, not just got discussed as a strawman like your 70-80 percent taxes). Believe me, one can go broke rolling over bonds while equities are levitated by monetary policy. I probably should have said “equities” are favored rather than “capital”. I guess my point is people really were affected by zero rates whereas nobody has been or will be taxed 80 percent.

  11. What she knows is that if you beat people to pulp with a baseball bat, most would not fight back or even make a sound. So, why not try?

    Imagine if all the rich people agreed (conspired) to say NO in solidarity with each other. As in, we’d rather make a charitable deduction to recruit a 2 million-strong private army with RPGs and attack helicopters, and we’ll let you talk to them while we relax in the Bermudas?

    I would be interested to see how that comes about. Will there be a brave Muller to indict the filthy rich parasites? 😉

  12. Move to Puerto Rico or move out of high tax states like NY and CA to
    zero tax states like WA, NV, TX and FL. Move to WA (no income tax) and shop in Oregon(no sales tax).

    If I have read the WSJ correctly, federal and state taxes in PR can be under 10% in total.

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