THE TRUTH ABOUT TAXES: History Suggests High Tax Rates On Rich People Do Not Hurt The Economy

US Income Tax Top BracketHistory of the top income tax bracket, 1913-2008.

Photo: National Taxpayers Union

The central issue of this year’s Presidential campaign will likely be the crappy economy.Specifically, the candidates will argue about how best to fix our high unemployment and massive budget deficit.

And one of the biggest points in that argument will be taxes.

Specifically, what should be done with them.

Obviously, no one likes paying higher taxes, and everyone likes paying lower taxes.

But we live in the real world, not fantasy-land. And in the real world, sometimes people have to do things they would prefer not to do–such as pay taxes.

But the disagreement on this issue, as well as the facts surrounding it, is intense.

Democrats, to the extent they care about the budget deficit, want to raise taxes, which they say are too low–especially on rich people.

Republicans, meanwhile, generally say that taxes are too high and that the budget deficit should be addressed with spending cuts. To get the economy back on track, Republicans argue, you need to give Americans an incentive to work hard–by letting them keep more of what they earn. Republicans also argue that raising taxes would clobber an already fragile economy.

So who’s right?

Are taxes too high? Or are they too low?

Do high tax rates on “rich people” create a lazy population in which no one has an incentive to work hard?

And what about the Republican mantra that cutting taxes is always good for the economy, while raising taxes is always bad?

Thanks to the Tax Foundation and other sources, we’ve analysed tax rates over the past century, along with government revenue and spending over the same period.

This analysis revealed a lot of surprising conclusions, including the following:

  • Today’s government spending levels are indeed too high, at least relative to the average level of tax revenue the government has generated over the past 60 years. Unless Americans are willing to radically increase the amount of taxes they pay relative to GDP, government spending must eventually be cut.
  • Today’s income tax rates are strikingly low relative to the rates of the past century, especially for rich people.  For most of the century, including some boom times, top-bracket income tax rates were much higher than they are today.
  • Contrary to what Republicans would have you believe, super-high tax rates on rich people do not appear to hurt the economy or make people lazy: During the 1950s and early 1960s, the top bracket income tax rate was over 90%–and the economy, middle-class, and stock market boomed.
  • Super-low tax rates on rich people also appear to be correlated with unsustainable sugar highs in the economy–brief, enjoyable booms followed by protracted busts. They also appear to be correlated with very high inequality. (For example, see the 1920s and now).
  • Periods of very low tax rates have been followed by periods with very high tax rates, and vice versa. So history suggests that tax rates will soon start going up.

Don’t take our word for it, though.

Let's begin with a look at the top income tax bracket since the federal income tax was started in 1913. As you can see, relative to history, it's currently VERY low.

And before you protest that INCOME taxes may be low, but the government is now gouging us a thousand new ways, note that total government tax revenue (federal, state, and local) is actually now lower than pretty much any time in the last 40 years. (Not as low as it was in the first half of the last century, though!)

The federal portion of that tax revenue--the blue part in the chart below--is in the same range as it has been in since 1950 (15%-20% of GDP). State (red) and local (green) tax revenues are in a similar long-term range. (State revenue has actually shrunk of late).

And here's another look at federal spending as a per cent of GDP for the past century. It's not way out of whack these days, at least relative to the last 60 years. But, thanks to the stimulus, it's higher than it has been since World War 2. (And the Republicans are probably right--it's too high).

And now for a closer look at those income taxes--the ones everyone loves to fight about. First, a refresher course: Here are the current federal income tax rates. 10%-25% rates for most people, and 35% in the top bracket (over $379,000).

And now, finally, a reminder of where that top bracket (35%) sits in the history of top tax brackets. (It's very low). Let's take a closer look at that history...

In 1924, tax rates were cut. The top rate was slashed from 73% to 46%. And the top bracket was reduced to $500,000 of income (again, many millions in today's dollars).

The next year--1925--the tax cuts continued. The top rate was slashed to 25%, down from 73% just two years earlier. The highest wage earners--those who made $100,000 and up--got to keep a vastly larger share of their income than they had only a few years previously.

By 1932, with the country's economy in a shambles, the tax code changed again. The high rates on top earners were reintroduced. Now, anyone who made over $100,000 was in a 56% bracket (versus 25% in the late 20s). And those earning over $1 million paid 63%.

Then, in 1936, with the economy still in horrible shape and the deficit soaring, the country really socked it to rich folks. Anyone making over $100,000 had to pay 62%. Anyone over $1 million, 72%. And the top rate--for incomes over $5 million--soared to 79%. (This would be the equivalent of having a tax bracket for those who made ~$20 million and up today). These tax hikes were later blamed for throwing the economy back into recession.

In 1941, income tax rates went even higher. The top bracket hit 81%.

And then, in 1945, with the country loaded to the gills with war debts, the top bracket hit an all-time high: 94%. This was assessed on anyone making more than $200,000. (Next time you hear bitching about how unfair it would be to raise our top bracket a few percentage points from 35%, remember that).

The following year, 1946, rates were trimmed a bit. The top rate was reduced to 91%.

And taxes stayed pretty much just that way for the next 15 years, until the early 1960s. Importantly, this was one of the most successful eras in US economic history. The middle class boomed, the economy boomed, and the stock market boomed. And all with the top marginal income tax rate over 90%. This suggests that the Republican mantra about high marginal tax rates killing the economy is, well, a bunch of crap.

Then, in the early 1960s, rates began to drop. Slowly, at first...

Then in bigger increments...

By 1965, the top bracket was down to 70%.

And there rates stayed, right through the early 1980s. The economy of the 1970s, of course, was horrendous--a condition that was later often blamed on high marginal tax rates. Based on the history of the 1950s, however, which had higher marginal tax rates, the cause of the 1970s misery was more likely stagflation.

In any event, in the early 1980s, Ronald Reagan came along. And he started cutting taxes. In 1982, the top marginal rate dropped to 50%.

Five years later, Reagan slashed taxes again, cutting the new top rate to 38.5%. (Note that this rate is still higher than today's.)

And then, in 1988, Reagan finished the job, whacking the top rate to 28%.

But suddenly we had a huge deficit to worry about. So George Bush 1 raised rates a bit. The top marginal rate bumped up to 31%.

But taxes were too high for George Bush 2, so he cut them. Just marginally, at first.

Then more significantly. In 2003, the top bracket dropped to 35%. The deficit reappeared--and then soared. And, interestingly, we saw a repeat of the 1920s: An unsustainable economic boom that ultimately collapsed, followed by a massive recession and huge deficits. And soaring inequality, which still plagues us today.

In 2010, with the economy still struggling, Barack Obama extended the Bush tax cuts for another two years. So here we are today.

So, what does the future hold? Good question! Obviously, no one likes tax increases, but the similarities between the 1920s-1930s and the 2000s-2010s seem hard to ignore. Today, after an era of very low taxes, we have enormous inequality and a huge deficit. Last time that happened, the top tax rate soared (and, it should be noted, the economy boomed--even with the top rate high). And we certainly wouldn't be surprised to see history repeat itself again...

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