From Blog Post to Peer Review: Higher Top Tax Rates Help America!

Back at the end of 2010, economist Mike Kimel wrote a blog post on Presimetrics speculating on the top marginal tax rate that would generate the highest levels of GDP growth for America.  His estimate was remarkably prescient.

In December 2010, Kimel made the following observation:

To maximize real economic growth in the United States, the top marginal income tax rate should be about 65%, give or take about ten percent. Preposterous, right? Well, it turns out that’s what the data tells us, or would, if we had the ears to listen.

He based this idea on historical GDP performance at various times under various tax regimes.  It turns out this “finger in the wind” was unbelievably accurate.  I’ve aggregated his research series over at The Masses.  He called this phenomenon “The Kimel Curve” in parody of the Lafer Curve.

Well now, in a new peer-reviewed paper by economists Peter Diamond and Emmanuel Saez, The Case for a Progressive Tax: From Basic Research to Policy Recommendations (pdf), the authors confirm Kimel’s conclusions.

We obtain three policy recommendations from basic research that we believe can satisfy these three criteria reasonably well. First, very high earners should be subject to high and rising marginal tax rates on earnings. In particular, we discuss why the famous zero marginal tax rate at the top of the earnings distribution is not policy relevant.

But they go further, they also find that tax subsidies for low income earners should be extended and that taxes on capital gains should be taxed, contrary to the standard fact-free GOP talking point.

Second, the earnings of low-income families should be subsidized, and those subsidies should then be phased out with high implicit marginal tax rates. This result follows because labor supply responses of low earners are concentrated along the margin of whether to participate in labor markets at all (the extensive as opposed to the intensive margin). These two results combined imply that the optimal profifile of transfers and taxes is highly nonlinear and cannot be well approx- imated by a flat tax along with lump sum “demogrants.” Third, we argue that capital income should be taxed.

And what number for the top marginal rate would the authors recommend?

 73% +/- 1%

Currently, the top marginal rate, all inclusive, is about 49.5%.  That’s 23.5% below where they should be for optimal GDP growth.  No wonder we’re stuck in the doldrums.

Kimel’s estimate of 65% +/- 10% proved remarkably accurate.  And now the results have been confirmed.  But, as Kimel questioned in his 2010 blog post, will anyone “have the ears to listen?”  Unlikely.