Raising Taxes on High Earners Could Backfire

The top federal income tax rate is already 37%, and additional Medicare-related taxes push the marginal federal tax burden on many high-income Americans above 40%. New research highlighted by the Tax Foundation suggests that further increases in the top income tax rate could generate little additional revenue and eventually leave governments collecting less.

The findings raise questions about proposals to address federal deficits by increasing taxes on high earners. While higher rates may appear to offer a straightforward way to raise revenue, taxpayers respond to changes in the tax code, and those responses can substantially reduce the amount governments ultimately collect.

The Federal Tax Burden Already Exceeds 40%

The 37% top federal income tax rate understates the actual marginal tax burden on many high-income taxpayers. Depending on the source of their earnings, additional Medicare-related taxes can raise the combined federal rate to 40.8% or higher.

Self-employed taxpayers face a 2.9% Medicare tax and an additional 0.9% Medicare tax on earnings above certain thresholds. High-income employees face a 2.35% employee Medicare tax, while employers pay another 1.45%.

Investment income can face the separate 3.8% Net Investment Income Tax (NIIT), which applies to certain investment earnings above specified income thresholds. Income subject to both the top ordinary income tax rate and the NIIT faces a combined federal marginal rate of 40.8%.

These figures exclude state income taxes, which can push the total marginal tax burden substantially higher in states with elevated tax rates.

Research Finds Limited Revenue Gains From Higher Rates

A study highlighted by the Tax Foundation examines the revenue-maximizing top income tax rate using the economic principles behind the Laffer Curve.

The Laffer Curve describes how tax rates affect government revenue. At lower rates, tax increases generally produce additional revenue. As rates rise, however, taxpayers have greater incentives to reduce taxable activity, change how they earn income, or shift income into more favorable tax categories. Eventually, these responses can become large enough that additional rate increases reduce total collections.

Economists Rachel Moore, Brandon Pecoraro, and David Splinter estimate that the top federal income tax rate that maximizes combined federal, state, and local revenue is approximately 39%, only slightly above the current 37% rate.

Their analysis finds that increasing the top federal rate from 37% to 39% would raise combined government revenue by approximately $1 billion. Much of the additional federal revenue would be offset by lower collections at the state and local levels.

The study does not conclude that a 39% rate maximizes federal revenue in isolation. Its findings instead demonstrate how higher federal taxes can reduce other government revenue and produce much smaller overall gains than a simple calculation based on existing taxable income would suggest.

Higher Rates Could Undermine the Revenue They Are Intended to Raise

The research has direct implications for proposals to increase taxes on high-income Americans. With the top federal income tax rate already at 37% and additional taxes pushing many taxpayers' marginal burdens above 40%, there may be considerably less revenue available from further rate increases than supporters anticipate.

Higher marginal rates can affect decisions about working, investing, expanding businesses, and realizing taxable income. They can encourage taxpayers to defer earnings, change business structures, or pursue other legally available ways to reduce their tax liabilities.

These behavioral responses are particularly important when evaluating tax increases on high earners, who often have greater flexibility in how and when they recognize income.

Although the study does not establish that every increase above the current 37% rate would reduce federal revenue, it suggests that the United States is already close to the rate that maximizes total government collections under the existing tax structure. Further increases could therefore produce diminishing returns or eventually reduce revenue.

The findings reinforce the limitations of treating higher tax rates as a solution to persistent federal deficits. Federal spending continues to outpace revenue, and raising marginal rates cannot be assumed to close that gap without consequences for economic activity and the broader tax base.

CFE Takeaway

The top federal income tax rate is already 37%, with additional Medicare-related taxes pushing the marginal burden on many high-income taxpayers above 40%. Research highlighted by the Tax Foundation suggests that increasing the top rate would yield little additional revenue across federal, state, and local governments, with further increases potentially reducing total collections.

Washington's fiscal problems are driven by spending that consistently exceeds revenue. Policymakers should focus on controlling federal expenditures rather than relying on higher marginal tax rates that could discourage economic activity while delivering far less revenue than anticipated.