Tax the very rich and solve the PBO problem

A guest post from PEF Steering Committee Marc Lavoie of the University of Ottawa:

Tax the very rich and solve the PBO problem

Among the dozen or so sessions I attended at the meeting of the Canadian Economics Association last week-end in Quebec City, one was devoted to the forthcoming fiscal crisis and another to income inequality. Kevin Page, the Parliamentary Budget Officer, told us that more fiscal resources had to be raised to finance the future costs arising from population aging. On the other hand, Michael Veall, from McMaster University, provided numbers showing the evolution of the shares of personal income (excluding capital gains and government transfers) declared by Canadian tax filers.

When advocacy groups say that the rich should be taxed more, the reply from the usual right-wing think-thank is that there are very few rich people and that an increase in the marginal tax rates of the highest brackets would not generate much revenue. But the top 1% income group now collects 13.8% of total market income (in 2007) which is nearly twice as much as it did in the mid-1980s (8.0% in 1985-1986). Couldn’t we recuperate part of that gain by raising marginal tax rates of very-high income earners?

Suppose we create a new tax bracket for the very rich, defining these as the top 0.5% of income earners (1 Canadian out of 200). In 2007, this would only concern Canadians earning more than $247,000 (not counting their capital gains).This population gets 10.4% of all market income. Suppose we raise the highest marginal tax rate by 50% (so if at 40%, it would become 60%, or if at 46%, it would become 69%). It can be computed that 4.2% of all taxable income would be subjected to this new tax bracket, meaning that the combined federal and provincial governments could collect additional taxes representing 2.1% of market income. As an approximation, this market income represents about two thirds of GDP, so it means that this sole change to income tax could bring in an increase of 1.4 points in the tax share of GDP. This would help to alleviate some of the fears of the PBO. In addition, taxing the rich, whose propensity to save is presumably much higher than that of the poor, would have a beneficial impact on the macroeconomy.