Taxing the $5 Million-a-Year Brigade

March 18, 2009

David Leonhardt wants to hike taxes on the very highest earners:

Today’s tax code makes no distinction between income above $373,000 and income above, say, $5 million. Both are taxed at 35 percent.
That is a legacy of the tax changes of the early 1990s, when far less of the nation’s income went to millionaires. Today, you can make a good argument for a new, higher tax bracket on the very largest incomes. In the past, the economist Thomas Piketty says, higher marginal tax rates tended to hold down salaries and bonuses, because executives had less incentive to angle for multimillion-dollar pay.
Do these ideas stem in part from anger and bitterness? Of course they do. How can you not be a little angry and bitter about the role that huge, unjustified pay played in causing the worst recession in a generation?
In fact, that’s sort of the point. Given the damage that’s been caused by our decidedly unmeritocratic system of paying executives, the most irrational course of all would be the status quo.

Creating a new tax bracket for people making more than $5 million a year wouldn’t raise a huge amount of money for the government, but that’s not the point — just as the reason that people like me want to claw back bonuses from AIG has nothing to do with recouping any significant portion of the money that the government has poured into the insurer.

The point is that incentives matter, and that if you skew people’s incentives with horribly-designed winner-takes-all pay structures, you’re liable to get extremely nasty consequences.

I’m reminded of Dan Ariely’s TED talk on cheating: if you create an atmosphere where large sums of money start to lose all meaning, people are going to cheat more. And when pay soars past the $5 million-a-year mark, it no longer has any connection to expenditures: it’s just a race, really, to see who can make the most money.

One person infected by such a mindset is Evan Newmark, who’s nicely stilettoed by Ryan Chittum:

Think about your own behavior in the giddy pre-Crash years. Did you bully a raise from your boss when one of your colleagues left? Did you buy a little condo in Miami to cash in on the boom? Did you throw more money into brokerage stocks as they rose higher and higher?

Well, outside the bubble the answers for 99 percent of us are : No, no, and no.

Is it the job of fiscal policy to create a tax regime which mitigates against the formation of devastating bubbles? I don’t see why not; it might even fit in with the behavioral-economics bent of the Obama team. But still, I doubt this is going to happen: it’s quite un-American. Many people work very hard, in this country, because they dream of one day pulling down a spectacular seven-or eight-figure income. Does Obama really want to kill that highly-motivating dream?

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