Alexandria Ocasio-Cortez Has the Better Tax Argument

A 70 percent marginal rate could help, not hurt, innovation.

When Alexandria Ocasio-Cortez suggested this month that the United States should tax income over $10 million by 70 percent, it galvanized something unusual: a broad and substantive national conversation about the design and purpose of federal tax policy.

No, I’m just kidding. It kicked off a lot of screaming about socialism, especially on cable news.

From the cacophony of communist callouts, however, a subtler argument emerged. Entrepreneurs and center-right economists insisted that raising taxes dramatically on the rich would undo America’s ability to spark innovation and attract entrepreneurs who want to start companies and solve big problems.

In the abstract, their case is clear. “If income taxes are high enough, start-ups stop happening,” said Paul Graham, the founder of Y Combinator, the country’s preeminent start-up incubator.

That perspective is backed by some research. A 2018 paper by Charles I. Jones at Stanford University Graduate School of Business found that raising the top marginal tax rate to 75 percent would “reduce innovation and lower GDP per person in the long run by about 6 percent.” Another recent paper found that the introduction of the income tax in 1909 suffocated innovation in the next 100 years. The conservative economists R. Glenn Hubbard and Douglas Holtz-Eakin each published papers earlier this century arguing that raising taxes on the rich “discourages entry into self-employment” and makes self-employed people less likely to hire workers.

Although it seems doubtful that an individual would choose not to start a company for fear of tax consequences should she become a millionaire—the horror—let’s give this argument its fairest shake. If high incomes are the prize that motivates entrepreneurs, high marginal rates weaken the prize and make it harder for new firms to scale up. Plus, reducing entrepreneurship in one generation might deplete the supply of start-up advisers and investors for the next.

Now let’s lift our eyes from theory and look out into the real world. Does it reflect conservative logic?

I don’t think so.

• The two most important hubs of innovation in the United States are the Bay Area and New York City. But according to the Tax Foundation, California and New York have the 48th and the 49th most favorable business-tax climates in the country. Sky-high tax rates in Mountain View and Manhattan haven’t blunted their advantage.
• Average tax rates on most income groups have been declining since the early 1980s, which you’d think would supercharge start-ups, but the official entrepreneurship rate in the United States has been falling over that entire period.
• The United States has lower marginal tax rates on income than much of the Organization for Economic Cooperation and Development does, but the U.S. entrepreneurship rate is lower than those of many Western and Central European countries.
• When the top marginal tax rates were about 90 percent in the 1950s and ’60s, the U.S. productivity rate was higher, men landed on the moon, and scientists invented the internet, satellites, and the transistor, planting the seeds of the entire computer revolution that now defines innovation.

These anecdotes don’t prove anything magical about high marginal rates, or low marginal rates. Rather, they suggest that if taxes matter, other stuff matters more—such as culture, local professional networks, and the state of scientific research.

As John Fernald, an economist at the Federal Reserve, once told me, economists can’t rule out the possibility that productivity has slowed down recently because “we picked all the low-hanging fruit from the information-technology wave.” If capitalist entrepreneurs want to pluck new fruits of innovation, he said, somebody needs to plant new seeds of scientific research.

The U.S. government used to do this well. Fracking, which has made the United States the world’s energy leader, came from federally funded research into drilling technology. The latest surge in cancer drugs came from the War on Cancer, announced in 1971. But the U.S. government doesn’t plant seeds like it used to. Federal research spending has fallen from nearly 12 percent of the budget in the 1960s to 4 percent today. If economists want to jump-start innovation in new frontiers, maybe they should obsess more about federal research spending than about a tax rate that would kick in at $10,000,000.01.

Another reason to worry less about marginal rates is that taxes collected from rich people are not boarded onto a spaceship and blasted at the sun. They help to support a range of services and benefits, some of which can make innovation more likely. Conversely, a lack of benefits can depress innovation.

In fact, one reason for America’s relatively low rate of start-ups may be that, since most adults get health care from their employer, they’re tethered to their day job. Some economists call this “entrepreneurship lock.” Universal public insurance might unlock ideas that are sequestered by the employer-sponsored health-care model. Relatedly, young people might not try to start a company because they are afraid of failure in a country without much of a social safety net. In one recent survey, more than 40 percent of 25-to-34-year-old Americans said a fear of failure kept them from starting a company in 2014—almost twice the number who said so in 2001. Higher taxes would likely help, not hurt, this cohort, if they were spent on, say, lowering the cost of public colleges, which would in turn reduce student debt and make it easier for middle-class graduates to take a risk on a new idea.

Entrepreneurs aren’t just born tough; they’re born lucky. The majority of successful young founders come from affluent white families, and they often piggyback on the professional connections and business expertise of their parents. Taxing the rich and distributing their income would do nothing to change the networks or tutelage of rich families, but it would reduce precarity among middle- and lower-class families, thus helping nonaffluent children become founders without doing much to punish their richer peers.

If Ocasio-Cortez wanted to destroy the American culture of innovation, she wouldn’t propose a barely applicable marginal tax rate, which exists within a larger tax code, which itself exists within a larger fiscal policy. Instead, she would reduce research funding, protect employer-sponsored insurance to keep tomorrow’s founders locked inside today’s cubicles, and increase student debt to make youth entrepreneurship more precarious. Oh, wait.