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The Cost of a 70 Percent Marginal Tax Rate

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High tax rates discourage young people from investing in themselves.Veronique de Rugy and Jack Salmon write:

Changes in marginal tax rates not only lead to changes in federal revenues, but also have a broader effect on human capital accumulation and labor market efficiency. Aparna Mathur, Sita Slavov, and Michael Strain have explained that in the long term, a more progressive tax system reduces the incentives to accumulate human capital:

“Earlier decisions such as education and career choices affect later earnings opportunities. It is conceivable that a more progressive tax system could reduce incentives to accumulate human capital in the first place. At 70% tax rates, a high school student may choose not to pursue his dream of becoming an engineer, or a small business owner may choose not to expand their business.”

To put it another way, proposals to impose high marginal tax rates do not account for the incentive to enter high-earning occupations. Making career choices includes weighing the expected return of educational investments and the cost of forgoing alternative opportunities. A 70 percent marginal tax rate would, therefore, act as a disincentive for people to pursue high-earning occupations. Michael Strain notes that “a young person interested in health care might decide to become a nurse rather than a surgeon, because much of the income gained from being a surgeon will be taken by the government. . . . In this case, our hypothetical young person isn’t deciding to be a nurse because that’s her preference—instead, she’s making the decision because the top rate is so high.” There is no doubt that this sort of tax-driven inefficiency makes society worse off.

[Veronique de Rugy and Jack Salmon “The Cost of a 70 Percent Marginal Tax Rate,” Mercatus Center, February 11]

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