Saturday, April 12, 2014

Myth: 90% taxes had no effect on growth in the 1950's

Proponents of high taxes on the wealthy argue that the government used to force the wealthy to pay 90% of their income in taxes and the economy did great. This isn’t exactly true. Here are some reasons why:

-Only a small portion of wealthy people’s income was subject to the 90% tax rate.
Since the US has a progressive income tax, the 90% rate only applied to a person’s income after they reached a certain income level. As you can see in the chart on the left, the top marginal tax rate was over 90% throughout the 40’s and 50’s until 1964, when it was lowered to 77% [1]. However, top tax rates are applicable to different income levels over time. The 90% top tax rate applied to every dollar earned after someone earn $2.3 million during the 40’s and 50’s (in 2011 dollars). In contrast, today’s top tax rate is 40% in applies to every dollar earned after a person earns $388,000 (in 2011 dollars) [1]. It’s also worth noting that the poorest income earners faced income tax rates of 20% in the 40’s and 50’s vs. 10% today [1]. In the end, the 90% tax rate applied to a very small percentage of income to a very small percentage of people.

-During the 40’s and 50’s, rich people didn’t pay the 90% rate.
The statutory tax rate is the legally imposed tax rate. However, most people don’t pay taxes at this rate due to the numerous tax deductions, credits, etc  which they use to reduce their tax liability. Thanks to all these “loopholes” the rich paid a fraction of what the government wanted. The graph on the left compares the top statutory rate to the top effective rate, which is the rate that people actually paid once they hit the top tax bracket. As you can see, top effective rates have remained steady around 25% throughout the 20th century [2]. The graph on the top right also shows that federal income taxes as a % of the economy have remained relatively constant throughout the 20th century as well. The middle graph on the right shows that federal revenues as a % of the economy have been steady over US history [3], while the graph on the bottom shows that US federal government spending as a % of the economy has followed a similar trend [4]. (However, total government spending as a % of the economy has risen steadily over time).


Historically, it appears as though the high statutory tax rates have had no effect on government revenues. Then again, we wouldn’t expect them to for the reasons given above. One thing that is worth noting is that in the early 1980’s, the federal government under Ronald Reagan cut top taxes rates dramatically from 70% to 50% in 1982, then from 50% to 39% in 1987, and from that to 28% in 1988 [1]. Although leftists may attack this as “trickle-down economics”, it should be noted that Reagan cut taxes for everyone and more importantly that the top effective tax rate under Reagan wasn’t significantly different from the top effective tax rates in the 40’s and 50’s, when statutory rates were above 90% [2]. This is because Reagan closed tax loopholes and cut taxes. Reagan’s tax cuts weren’t a giveaway, they were meant to make the tax code more efficient and transparent. According to one person over at EconomicPolicyJournal.com:

The dishonesty or perhaps ignorance in the tax debate that is going on today is the complete misrepresentation of the pre-TRA86 [Tax Reform Act of 1986] higher marginal rates in the old ’53 code. Sure the marginal rates were insane, but the underlying tax code was rife with loopholes that a good tax planner (I was one) could exploit to get a person’s effective tax rate as low or lower then it is today. Those loopholes are no longer part of the tax code which is a good thing as they encouraged investors to invest in projects that had no economic viability other then the income sheltering effect they created” [5]

-Empirical evidence finds that taxes are incredibly detrimental to growth.

Christina Romer, a leading Keynesian economist behind the 2009 stimulus package, authored an empirical study with her husband titled, “The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks”. In the study, the Romers examine the economic history of the United States and study how changes in tax revenue as a percent of the economy affect economic growth. Their findings are unsurprising to supply side economists, but utterly destructive to the arguments for higher made by those on the left. According to the Romers:
We then examine the behavior of output following…exogenous legislated [tax] changes. The resulting estimates indicate that tax increases are highly contractionary. The effects are strongly significant, highly robust, and much larger than those obtained using broader measures of tax changes. The large effect stems in considerable part from a powerful negative effect of tax increases on investment.” [6]
When they say highly contractionary, they mean it. According to their research:“[W]e find that a tax increase of one percent of GDP lowers GDP by about 3 percent” [6]It’s worth noting that it’s not just Romer’s study that find that taxes harm growth, the majority of empirical research does. See citation [7]In conclusion, the claim that wealthy people faced over 90% tax rates in the 1950’s is a half-truth. No one actually paid those high rates due to an immeasurable amount of loopholes written into the income tax code. Additionally, empiricists have studied the effects of taxes on economic growth in the United States and the results indicate that tax increases are highly contractionary, much to the dismay of left wingers who promote such tax increases.
Citations:
[1] http://en.wikipedia.org/wiki/Income_tax_in_the_United_States#History_of_top_rates[2] http://blackburn.house.gov/uploadedfiles/jec_republican_staff_analysis_historical_tax_rates_rhetoric_vs_reality.pdf.pdf[3] http://www.usgovernmentrevenue.com/revenue_history[4] http://www.usgovernmentspending.com/past_spending[5] http://tomwoods.com/blog/didnt-we-used-to-have-high-taxes-and-prosperity/[6] http://www.nber.org/papers/w13264.pdf?new_window=1[7] http://taxfoundation.org/article/what-evidence-taxes-and-growth




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