Raising Taxes on the Rich Can Have Unintended Consequences

By Elizabeth Guner, Victor Lee and Simone Liao

Penn Wharton Budget Model Senior Economist Richard Prisinzano discussed raising taxes on the wealthy with Alan Auerbach, Professor of Economics and Law at University of California Berkeley, and Knowledge@Wharton host Dan Loney. You can listen to the full discussion below.

Presidential candidate Senator Elizabeth Warren (D-MA) recently floated the idea of a 2 percent tax on assets over $50 million. In addition, Representative Alexandria Ocasio-Cortez (D-NY) supported the idea of a marginal tax rate of 70 percent on income above $10 million. Prisinzano explained that a high marginal tax rate at this level of income would encourage tax avoidance activities. According to Prisinzano, the objective of this proposal symbolically reflects the desire to tax the extremely wealthy and tackle income inequality. An incentive for tax avoidance would work against that goal.

Such taxes on income and wealth are likely to have significant effects on behavior, similar to those observed in reaction to tax changes under President Reagan. Prisinzano and Auerbach believe high earners would be more aggressive with tax avoidance methods should these proposals materialize into policy.

High income business owners are likely to convert pass-through businesses to C-corporations to reduce tax obligations. PWBM recently showed that once this effect is considered, Representative Ocasio-Cortez’s idea raises only 43 percent of the revenue it would otherwise.

From this year’s tax cuts, Auerbach and Prisinzano identify the cut in marginal tax rates and the cap on state and local tax (SALT) deductions as having the largest impact on households. In addition, the increase in the standard deduction may also lower how much households donate to charity. One beneficiary of the Tax Cuts and Jobs Act (2017) are tax preparation service providers, as more individuals will be unfamiliar with the new policy. However, tax returns will be simpler for the many households who used to itemize that will now use the higher standard deduction.