Why Higher Tax Rates Don’t Necessarily Mean More Revenue

One of President Obama’s major agenda items when he came into office was raising tax rates on the wealthy.

He succeeded: Through Obamacare and the 2013 fiscal cliff tax hikes, he raised rates on their wages, capital gain, and dividend income.

And while it’s true that revenues are likely higher today than they would’ve been had those hikes not occurred, the long-term picture isn’t as rosy. Historical evidence shows it’s probable that revenues will return to around the same level they were before the tax hike.

onsider the chart above, recently released by The Heritage Foundation in its annual Federal Budget and Pictures publication.

It compares changes in the top individual tax rate to changes in total individual tax revenue over the past 50 years. Despite wide variations in the top individual rate—fluctuating between 91 percent and 28 percent tax rates for the richest Americans—total individual revenue has remained fairly stable as a percentage of GDP.

The data suggests that lowering marginal tax rates will not substantially reduce federal revenues, nor do higher rates increase collections.

How can we explain this? The answer comes from the economic effects of tax hikes. Higher marginal rates discourage work, output and employment, leading to lower incomes for individuals. Thus, while increasing rates may bring a higher proportion of incomes into the federal treasury, it also reduces the overall income base these rates are able to draw from.

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