The Trouble with Taxing Top Earners: Postwar economic growth does not demonstrate high top rates are harmless

Ben Eisen, Commentary, Taxation, Uncategorized

In a series of recent columns following up on their book The Trouble with Billionaires, Linda McQuaig and Neil Brooks lament the growth of income inequality in Canada. The authors observe that incomes for households at the top of the distribution have increased much faster than households at the middle and the bottom in recent decades. This phenomenon deserves careful analysis to determine its causes and what sort of policy response is appropriate. However, the authors’ interpretation of economic history is problematic, leading them to embrace potentially ruinous policy prescriptions.

Brooks and McQuaig view the increased concentration of wealth in the hands of the most affluent Canadians as a serious social problem. Their major proposed policy response is to drastically increase taxes on high-income Canadians. The rich benefitted disproportionately from recent economic growth, their argument holds, and by taxing them more the rest of society can recapture some of the wealth.
The obvious concern is that higher taxes for top earners would stifle economic growth. McQuaig and Brooks anticipate this response, describing it as discredited “right-wing theory.” As evidence, the authors point to the early postwar period during which top tax rates and the pace of economic growth were both high. In Canada, the top marginal rate was almost 80 percent until the late 1960s. In the United States, the top rate was 90 percent in those high-growth years.
These numbers alone appear to make a slam dunk case against the notion that high taxes on top earners stifle growth. The reality, however, is more complicated. Although official top rates were high back then, there were countless loopholes high-income individuals exploited to keep tax bills manageable. The history of tax rates in Canada has been a process of lowering top rates while closing these loopholes, rationalizing the system while keeping the share of taxes paid by wealthy Canadians roughly unchanged.
 In 1999, Simon Fraser University economist Herb Grubel calculated changes in the share of all income taxes paid by high-earners over time. Grubel found that in 1967, when Canada had an 80 percent top rate, the top one percent of earners paid approximately 18 percent of all income taxes collected by the federal government. Amazingly, despite large top rate reductions, the percentage of income taxes paid by the top one percent barely budged over the next thirty years. Rapid real income gains at the top partly offset rate reductions, but the elimination of loopholes also played an important role in keeping the share of income taxes paid by high-earners constant as rates fell dramatically.
Thanks to loopholes, incentives to shift money abroad and the ability to participate in black markets, the high official tax rates in early postwar North America were relatively easy to get around. David Frum has written that high marginal rates in the United States “functioned more as symbols than as real means of redistribution.” Grubel’s data suggests the same was at least partly true in Canada. The evidence from the postwar era shows you can get away with stratospheric tax rates without crushing economic growth –  if there are ways for people to avoid those taxes. It does not prove we could actually extract 80 percent of highly productive people’s incomes without strangling the economy.
Furthermore, even if the evidence did suggest high taxes didn’t dampen growth in the postwar years, that wouldn’t mean the results would be the same today. There is now a global market for executives, and high earners are increasingly footloose. The miserable results of the recent creation of a “millionaire tax” in Maryland show what can happen when jurisdictions try to disproportionately hike taxes on top earners. One-in-eight of Maryland’s million dollar earners in 2007 filed no return at all in 2008, when the tax went into effect. Some people had died, but others just moved. Total income taxes collected from millionaire filers plunged 22 percent. This example shows raising taxes on high earners can backfire if done incautiously.
Contrary to McQuaig and Brooks’ suggestion, the evidence from the early postwar era does not show that we could safely extract much more tax revenue from high-earners. A system that actually taxed productive activity at anywhere near 80 percent on a large scale would almost certainly slow down the economy. This is not “right-wing theory,” it is mainstream economic thought. The authors have identified a real economic malady in slow income growth for middle-class and poor households. Their proposed remedy, however, would likely reduce economic growth, hurting families across the entire income distribution.