How to Tax the Rich

President-elect Joe Biden is forming a transition team to assume office in January, but the outcome of some Senate elections are still outstanding. While the exact congressional makeup is unclear, more is known about the Biden-Harris transition team, which now includes noted Harris faculty and tax economist, Professor Damon Jones. As such it is imperative to unpack key campaign proposals through the lens of a split Congress, and ask, “what can pass with a divided government?” Following an election that often focused on political controversies, analyzing policy proposals is difficult because few proposals were clearly articulated—with the exception of tax policy.

During the most recent presidential debates, former Vice President Joe Biden’s tax plan was brought to the forefront. President Donald Trump has criticized Biden’s plan on the basis that the policy would raise tax rates on annual incomes of over $400,000. Furthermore, this proposal was not presented as a means to increase government revenue or fund a specific program, but rather as a progressive mechanism to curb inequality—an important departure from the way tax increases are usually presented to the public. This debate took place against the backdrop of mounting empirical evidence showing an increased concentration of income and wealth at the top, partially informed by the formal tax system.

Concurrently, new insights from President Trump’s tax returns were recently published following years of investigative journalism. The reporting showed that the president, a wealthy real estate mogul, paid very little in income taxes for almost two decades. The contrast between a billionaire president, who spent a decade preventing any disclosure of personal tax information, most likely to hide exactly how little taxes were paid, publicly complaining about a plan that would marginally raise taxes on upper incomes was striking.

Although these issues attracted outsize attention during the campaign, they are not new. Certainly, the concern over President Trump’s taxes are a subset of the broader issue of inequality that predates the current administration; likewise, the solution that Biden is presenting partially comes from somewhat dated economic literature. The $400,000 threshold that President Trump criticized is not an incidental number, but rather a figure that most likely comes directly from a seminal paper on optimal taxation first published in 2011 that stems from literature that dates back to the 1970s.

There is a growing body of research that links regressive changes to the tax code directly to broadening inequality. There is also a secondary empirical literature that focuses very specifically on quantifying exactly how rich the wealthy have gotten as a result. That empirical literature can be contentious and is largely made up of a few teams of very notable economists. Namely, those teams are Thomas Piketty of the Paris School of Economics, Emmanuel Saez and Gabriel Zucman of U.C. Berkeley, as well as Chicago Booth Professor Erick Zwick, Owen Zidar of Princeton University, and Matthew Smith of the U.S. Treasury Department, and finally Gerald Auten of the Office of Tax Analysis at the U.S. Treasury Department, and David Splinter of the Joint Committee on Taxation. Following Piketty and Saez’s groundbreaking research on income inequality, these research teams have consistently updated prior estimates. While these researchers often disagree on exact estimates, and sometimes disagree very strongly, the general trend of rising inequality holds.

Regardless of the estimate, the data show that inequality is rising in the United States, and the topic has become more politically important as a result. With Elizabeth Warren’s wealth tax proposal, Alexandria Ocasio-Cortez’s statements on income taxes, and a new book by two of the aforementioned tax economists, Emmanuel Saez and Gabriel Zucman, tax policy has been foregrounded in the public discussion around inequality. Search results and polling data suggest that “Tax the Rich” proposals are gaining visibility and remain broadly popular. As such, it is helpful to unpack this issue and the solutions into relevant parts.

Biden’s plan is likely drawing on a famous paper by two noted economists, Nobel laureate Peter Diamond of MIT and Emmanuel Saez. In the article, Diamond and Saez argue for a more progressive income tax structure. The research lands on a tax rate of 73% as the optimal rate for incomes over $400,000. Other papers have since followed that work and have landed on different rates and different income levels by tweaking various assumptions. Importantly, however, those estimates have largely used the same formula that Diamond and Saez originally constructed. So, while academics may disagree on estimates, there is broad agreement that the underlying mathematics is correct. Notably, Biden’s plan would only raise the top tax rate to 39.6%, up from the current 37% for yearly incomes over $400,000.

Biden’s plan explicitly echoes elements of Diamond and Saez while refocusing American tax policy as a potential solution to rising inequality nationwide. This signals a strong contrast to President Trump, whose Tax Cut and Jobs Act was widely criticized as exacerbating income inequality through top-heavy tax breaks. The Biden proposal also offers policy substance to a discussion around taxing upper incomes that is often void of detail. Often, the “Tax the Rich” debate fails to identify who will be considered “rich” and how much they will be taxed, obscuring public discussion. Historically, the top income tax rate has hovered around 58%, with a height of 94% in the mid-1940s. During that same period, there were 24 tax brackets. Today there are only seven.

The politics of this reform passing remains difficult to project. Senate composition remains unsettled, with runoff elections in both Georgia senate elections. A narrow Democratic minority in the Senate would increase the pressure for the Biden tax plan to be presented as revenue neutral to side-step parliamentary rules that would prompt a 60 vote threshold. To do this, the plan would need a favorable scoring by the Congressional Budget Office, or another independent research institution. That would allow the bill to pass with a simple majority vote, pulling in support from the same group of median senators who were pivotal in the previous Congress.

Biden discussing adding another bracket or slightly raising the top tax rate is not novel. Rather, the proposal is well supported by the data, has deep connections to economic literature, and is historically fairly normal. The proposal would quite literally just return top tax rates to the level before the Tax Cut and Jobs Act. Despite some alarmist commentary, Biden’s top tax rate proposal remains well below the recommendation of Diamond and Saez. In fact, Biden’s proposal is also well below the historical average of top tax rates and the average of the academic literature on optimal taxation. So, the outstanding issue is not whether Biden’s proposal is too progressive, but rather whether the plan is too modest —which could prove to be a political advantage.

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1. Auten, Gerald, and David Splinter. “Top 1 Percent Income Shares: Comparing Estimates Using Tax Data.” AEA Papers and Proceedings 109 (May 2019): 307–11. https://doi.org/10.1257/pandp.20191038.
2. Diamond, Peter, and Emmanuel Saez. “The Case for a Progressive Tax: From Basic Research to Policy Recommendations.” Journal of Economic Perspectives 25, no. 4 (December 2011): 165–90. https://doi.org/10.1257/jep.25.4.165.
3. Piketty, Thomas, and Emmanuel Saez. “Income Inequality in the United States, 1913–1998.” The Quarterly Journal of Economics 118, no. 1 (February 1, 2003): 1–41. https://doi.org/10.1162/00335530360535135.
4. Piketty, Thomas, Emmanuel Saez, and Gabriel Zucman. “Distributional National Accounts: Methods and Estimates for the United States.” The Quarterly Journal of Economics 133, no. 2 (May 1, 2018): 553–609. https://doi.org/10.1093/qje/qjx043.
5. Smith, Matthew, Danny Yagan, Owen Zidar, and Eric Zwick. “Capitalists in the Twenty-First Century.” The Quarterly Journal of Economics 134, no. 4 (November 1, 2019): 1675–1745. https://doi.org/10.1093/qje/qjz020.