The Situation of High Marginal Income Tax Rates and Motivation

A leading rationale against progressively higher income tax rates for top-earners is that high taxes will dissuade them from working hard, being innovative, or trying to be the best at whatever they do. This rationale has seemingly prevented a return of the very high marginal income tax rates used between 1951 and 1963, when taxable personal income over $400,000 was taxed to the tune of 91% by the federal government.

Now-a-days, taxable personal income over $373,650 is taxed at 35% by the federal government (the percent will increase to 39.6% in 2011 if the Bush tax cuts are not extended or made permanent.  39.6% was used during the Clinton years.  When combining many states’ income taxes, the effective rate would–at least for those high-earners living in states with progressive state income taxes–jump to close to 50%, but still much lower than 91%).

Keep in mind, only about 1.5% of the U.S. population earns over $250,000 a year, so a marginal tax rate increase for those earning over $373,650 is not an increase that would directly impact the vast majority of Americans.  And yet such an increase is commonly viewed as harmful because it might, in the view of some, deter work ethic/innovation by those with entrepreneurial dreams and undermine a corresponding creation of jobs.

Is there any empirical or even anecdotal truth behind this rationale?  Over on Daily Kos, a writer unequivocally says no in his piece titled “No Country for Zuckerbergs.”  The piece details the extraordinary success of Facebook founder Mark Zuckerberg, the 26-year-old who is now worth close to $7 billion and whose company has made many of the 1,200 Facebook employees very well off.  The piece contends that innovative persons like Zuckerberg would not be dissuaded by higher taxes.  Here’s an excerpt:

* * *

Mr. Zuckerberg, for example, in 2004 was staring at a top marginal tax rate of 35 percent, the Bush rate. It seems to me he considered paying that rate of tax would be worth the cost of earning himself almost $7 billion. Does anyone really believe he would not have founded Facebook if the tax rate was 39.6 percent, the Clinton rate? Is that extra 4.6 percent such a huge obstacle to success, that Mr. Zuckerberg would have decided Facebook and its prospects weren’t worth the effort? How about Bill Gates of Microsoft staring at a top rate of 70 percent in 1979? Or perhaps Gordon Moore of Intel starting out with a top rate of 75 percent in 1968? Why did Bill Hewlett and Dave Packard start HP in a garage in 1939 with a top rate of 79 percent and then take the company public in 1957, during which time the top rate rose to 91 percent? 91 percent!

The fact is the idea that tax rates have anything to do with business creation is a myth. Nobody who has a great idea and good prospects is going to not go for it because of tax rates. Even if the tax rate was 100 percent over annual income of $1 billion, it isn’t going to stop someone who has some moxie for going for that $1 billion a year. Lets face it, a billion dollars is a good living. Furthermore, it has almost nothing to do with job creation. American Express surveyed small business this year and found only 18 percent cared about high taxes. Only 8 percent were worried about the federal deficit. When asked “Which of the following would most incent you to hire,” 67 percent of small businesses said more consumer demand or better economic outlook. Only 11 percent said tax credit.

* * *

An increase in the top marginal tax rate is going to have no effect whatsoever on job creation or business investment. Business success has nothing to do with income tax rates and everything to do with the old-fashioned things: passion, perseverance, inspiration, timing, moxie, and most of all luck.

* * *

To read the rest, click here.  To read other Situationist posts on taxes, click here.