Tax is back. A year after the GOP’s sweeping $2 trillion tax cut, energized members of the new left are talking about taxes in a way we haven’t heard in a long time—most notably Rep. Alexandria Ocasio-Cortez (D-N.Y.), who has proposed raising the top marginal tax rate, to 70 percent from the current 37 percent for income over $10 million.

Democrats believe the wealthy have benefited the most from the economic growth of the past several decades, and it’s time to ensure that all Americans share in that growth. Some want to reduce inequality for its own sake. Others argue tax revenues are needed for things that most Americans support, including public education, infrastructure, research and development, easing the transition to an automated economy, mitigating climate change, and addressing wage stagnation and the social fraying that it leads to.

All of those priorities point to higher taxes on the richest Americans. But what’s the best way to raise taxes on the rich? It’s natural to assume it would be by raising income tax rates at the very top. Ocasio-Cortez and other proponents of this idea often note that the top rate was as high as 70 percent as recently as 1980.

It’s true that it was under the administration of Ronald Reagan that the top tax rate fell from 70 to 50 percent (and eventually to just 37 percent), a move since remembered by anti-tax Republicans as one of the central successes of Reaganomics.

But it wasn’t Reagan who first proposed bringing the top rate down: It was Democrats in Congress who killed the 70 percent tax bracket. Their reasons for doing so hold important lessons for Ocasio-Cortez, Sen. Elizabeth Warren (D-Mass.), and any other progressive who wants to use the tax code to roll back income inequality and make the rich pay their fair share.

IT'S IMPORTANT TO remember that when Ronald Reagan took office, it was clear to everyone, including Democrats, that tax cuts would follow. The economy was in a recession, unemployment was high, and Reagan had campaigned on the idea that the best way to fix these problems was to cut taxes. Since Democrats controlled the House and Republicans had just taken control of the Senate, any tax cut legislation would have to be supported by majorities of both parties in order to get to his desk.

Unlikely as it may seem now, Republicans decided to keep the 70 percent top rate in place because they thought reducing it would be perceived as a giveaway to the wealthy. Reagan’s big 1981 tax cut was meant to be an across-the-board cut for all taxpayers, not skewed to business and the wealthy. In fact, business leaders were vehemently opposed to Reagan’s original plan, fearing it would blow up the federal deficit (which it eventually did).

It’s also worth remembering that the tax burden for most Americans was much higher in 1980 than it is today. For example, the middle quintile of Americans paid a federal tax rate of 19 percent in 1980, compared with 14 percent in 2015. Inflation was producing “bracket creep,” which meant that tax burdens were going up even while real wages were constant.

All this made the idea of across-the-board tax reductions popular, so much so that a strange dynamic developed. Congressional Democrats decided there was nothing to be gained from fighting Reagan’s tax cut, and they decided to propose a tax cut of their own. Over the next few months, Reagan and the Democrats presented dueling tax-cut bills, and they kept tweaking their bills to appeal to wavering members of Congress.

It was in this battle of the bills that the Democrats proposed to cut the top tax rate to 50 percent. They thought this would help attract votes from conservatives in both parties in the House. And importantly, they decided that in terms of revenue, the superhigh top tax bracket that draws so much political attention just didn’t mean very much: Of the $517 billion the Treasury collected in 1980, only $3 billion to $5 billion came from the 70 percent bracket — less than 1 percent of total tax revenue.

With the political cover that Democrats had proposed lowering the 70 percent top rate first, the Reagan administration was only too happy to adopt the proposal as part of their plan—and it was the Republican plan that ultimately won.

THE DEMOCRATS OF today should consider what the Democrats of 1980 knew: The top marginal tax rate generates very little income for the federal government. At the time, the 70 percent rate didn’t kick in until $212,000, which in today’s dollars is over $600,000. Since this was a marginal rate, no one, not even the richest millionaire, paid 70 percent of their entire income in taxes; only the portion of their income above the threshold was taxed at the top rate. Most important, the rich had ways to shift their income to avoid taxes, because the top rate only applied to “unearned income” such as dividends. This meant that whether the goal was to reduce inequality or raise revenue, the top tax rate was not very effective.

Does this mean progressives should forget the idea of taxing the rich? Actually, it’s possible to tax the rich, but the top tax rate by itself can’t do it. You also need to raise the capital gains tax. Many things are different today from 1980, but one important thing is still the same: The wealthy have options for shifting how they make money and where they keep it, and thus how they pay taxes. These days a major opportunity for tax-shifting by the wealthy is to take their income in the form of capital gains — proceeds from investments and other assets — instead of earnings. Capital gains are taxed at just 20 percent, much lower than the rate for ordinary income, which tops out at 37 percent. So, the wealthy who take their income as capital gains reduce their taxes significantly, and completely legally.

The capital gains tax dates back to the Revenue Act of 1921. The reasons for keeping taxes on capital lower than on ordinary income are not implausible: As the Democrats in 1980 noted, lower taxes on capital gains should stimulate investment, which should stimulate the economy. Indeed, back then the United States lagged European countries in its efforts to stimulate investment, and the U.S. actually taxed capital more heavily than European countries did. Cuts from the high capital gains tax rates of the 1970s may have made sense 40 years ago.

BUT TIMES HAVE changed, and tax rates are much lower today. There is no evidence that rates as low as today’s stimulate investment or benefit the economy, which means that lower capital gains tax rates are costing the government money. Nearly three-quarters of capital gains tax is paid by the top 1 percent of Americans, so treating capital gains as ordinary income (and closing related loopholes such as for carried interest and the “stepped up basis”) would meet the progressive goal of preferentially taxing the rich. These aren’t radical or new ideas: economists who study the capital gains tax have long argued in favor of equalizing the rates, and it has even been done before—by Ronald Reagan, in the tax reform law of 1986.

Pushing the capital gains tax modestly upward might not have the same emotional appeal to progressives as raising the top tax rate to a theatrical number like 70 percent, but it is critical to generating revenue. Estimating exactly how much revenue this would produce is difficult, because it depends on how successful the wealthy are at hiding their capital gains in other ways. But for comparison, Ocasio-Cortez’s suggestion would produce around $70 billion per year if there is no income shifting, around 2 percent of tax revenue; based on figures from the non-partisan Congressional Budget Office, taxing capital gains as ordinary income would raise a similar amount. And implementing both proposals together — taxing capital gains as ordinary income and raising the top rates — would make Ocasio-Cortez’s proposal lose much less revenue from income shifting. It still would not produce a European-style welfare state, because European welfare states are financed by heavy taxes on workers. But this plan could produce an additional 4 percent of tax revenue — enough to make a down payment on a Green New Deal, or to allow more Americans to buy into Medicare.

Ocasio-Cortez did us all a favor by opening a conversation that we’re going to have to have sooner or later on how to raise taxes, but her tax increase proposal by itself would do nothing to stop the wealthy from shifting even more of their income into capital gains.

In their excitement to tax the rich, Democrats should not forget that the wealthy have ways of escaping taxes. If you want the rich to pay their fair share, raise the tax on capital gains.

Monica Prasad is a professor of sociology and faculty fellow at the Institute for Policy Research at Northwestern University. She is the author of Starving the Beast: Ronald Reagan and the Tax Cut Revolution.

Authors: