Lowering Taxes to Raise Revenue

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The budget negotations in DC have basically come to an end, and one of the things that got nixed was a tax increase on those earning more than $200,000 a year. Many are upset by this; making the usual cries for fairness that go with arguments in favor of progressive taxation. I can’t speak to that, but I can respond to claims that higher taxes on upper income brackets are a practical necessity for addressing the District’s projected budget gap.

My argument is not a new one: lowering tax rates can, and in the District’s case, almost certainly will increase tax revenue.

The most famous case where this occurred is of the course the Reagan tax cuts, where the top marginal rate decreased but tax revenue increased. This could be attributed to a recovering economy, of course, but the distributional changes were interesting:

The share of the income tax burden borne by the top 10 percent of taxpayers increased from 48.0 percent in 1981 to 57.2 percent in 1988. Meanwhile, the share of income taxes paid by the bottom 50 percent of taxpayers dropped from 7.5 percent in 1981 to 5.7 percent in 1988.

In other words, while the marginal rate¬†decreased on top income earners, the percentage of tax revenue that came from those income earners actually increased–and this during a time when the overall amount of tax revenue had also increased.

I’m not going to pretend one example proves anything; I offer it up merely as evidence that the idea of lower tax rates yielding higher tax revenue is not at odds with reality.

It seems to me that the case for this in the District is particularly strong. DC’s political boundaries only account for one small part of the DC metropolitan region as a whole. As such, area residents are in a better position than most to “shop” for the most personally beneficial policy situation. Moreover, it should be obvious that the wealthier you are, the more options you have available to you. The “voting with your feet” option is more affordable to someone making more than $200K a year than to someone making $30K or $40K a year.

In short, raising the tax rate on people making more than $200K a year wouldn’t necessarily result in an increase tax revenue by a single dollar; it may just result in fewer people in that group filing their taxes in DC.

Moreover, I think a sufficient number of people who live in DC have relatives in Virginia or Maryland whose whom they could claim as their primary residence to make the tax base of the District more flexible than is typical.

The bottom line: I think that the most practical way for the DC government to increase its budget gap would not be to increase taxes on higher income earners, but to lower taxes across the board so that they are on par or slightly lower than the District’s neighbors. This would encourage many more people to file their taxes in DC.