As someone who has always believed that crippling tax rates cripple economic growth, I’ve always struggled to understand how our nation prospered under top income tax rates that were over 90% for the period between 1950-1963 (for those of you who neither debate Progressives nor follow the history of the tax debate this will come as a bit of a surprise.) In fact, from 1936 all the way through 1980 they were NEVER lower than at least 70%. Yes, there were ups and downs during these periods, but my point is that our nation worked, and prospered, during this time. We grew into the largest superpower in history, as a result of what we’ve always been told is our unique set of freedoms which spurred economic growth. So how can we believe that the individual PEOPLE made our country great when during this period men and women were obviously NOT entitled to the sweat of their own brow?
This is obviously very troubling for anybody who believes in the whole free market/capitalism economic model. Was the government able to skillfully steer the free market, obviously while collecting a massive amount of the Gross Domestic Product (GDP), by essentially controlling the bulk of the market? So what motivated people to work when the federal government alone was taking over 90% of their income? I thought perhaps the old income tax rates were merely significantly more progressive at the higher end, but a cursory analysis showed that even the LOWEST tax brackets during this period rarely paid less than 20%. With the federal government alone taking such a huge chunk of everybody’s paycheck, what motivated them to work? Have we actually gotten away from a long-lost core value of giving the government more of our hard-earned money? I decided to look at a historical rate of taxation on the total US GDP. I used the US GDP because I wanted to see exactly how much of the work product generated by the American people, going back through the beginning of the century, was normally soaked up in federal income tax. Here’s a graph of what I found:
Now, even if we account for MORE people falling into these higher and higher tax brackets, how on earth could Federal Income Taxes as a percentage of GDP hover in the 6-10% range through a seventy year period where income taxes went from 81.1% in 1940 clear up to 94% during World War 2, and stayed there clear up until Kennedy cut the top tax rate to 77% in 1964 (yes, you read that right) all the way to 2010, when the highest marginal rate was a paltry 35%? Even if we account for the quirks and complexities for which our tax code has been generationally known, if these marginal rates are accurate how do we reconcile this massive contradiction: deviations of nearly 300% in what our nation’s highest earners have paid in taxes but very little correlative change in revenue as a percentage of GDP? To further complicate things, if you look at ALL historic marginal tax rates they were generally higher than what they are today.
I was able to reconcile this oddity through some numbers that had previously been released by the Congressional Budget Office. Their numbers only go back as far as 1979, but I think they will give all of us some understanding about what’s wrong with this picture. In 1979, the highest marginal tax rate was 70%, however the highest EFFECTIVE tax rate for even the top 1% of earners was 21.8%! See, the MARGINAL tax rate is what we are subjected to before deductions, exemptions, tax credits, write-offs, etc. what have you. Our EFFECTIVE tax rate is what we all actually PAY, which for the sake of their analysis the CBO defined as total income taxes paid divided by comprehensive household income. When you hear the left speaking about how prosperous the nation was with such a high tax rate, they always refer to the marginal rate, but NEVER mention how much people actually PAID.
At this point we’ll talk in quintiles, since you had a vast fluctuation in who qualified for the highest income tax bracket through the last century, whereas dividing the population in fifths keeps the numbers of each respective tax bracket fairly even. Plus, these are the ratios the CBO uses. Where this gets really dicey is that in 1979 the lowest quintile (bottom 20%) of earners had an effective income tax of 0.0%. As of 2007, that had actually dropped to -6.8%, through a variety of tax credits, entitlements written into the tax code, etc. However, if we’re still talking in quintiles the top 20% in 1979 paid an effective tax rate of 15.7%, and as of 2007 that had only dropped to 14.4%! The top 1% have gone from 21.8% to 19.0% as well, with a yearly average of 21.3%. Obviously, everyone has paid less in taxes over the past 30 or so years, but who benefits more: the top 20% who have seen a drop of 1.3% in the taxes they actually pay, or the bottom 20% who have gone from paying nothing to seeing nearly a 7% surplus? Some will point out that the working poor DO pay taxes, in the form of payroll taxes, social security, etc. but that they simply don’t pay any income tax. Looking at total effective federal tax rates, to include income, social insurance, corporate, and excise taxes the lowest quintile went from 8% in 1979 to 4% in 2007, obviously a drop of 50%. However, the top 20% have gone from 27.5 to 25.1, a VERY far cry from the 50% drop the bottom fifth have seen. Again, we’re seeing a trend of top effective tax rates not fluctuating nearly as much as we’ve been led to believe. We’re also seeing effective income tax rates in the past 30 years dropping much more quickly for the working poor than the working rich.
Back to the income tax, I see no reason to think that this comparison, a 70% top marginal rate but the absolute highest earners having an effective rate of 21.8%, isn’t a reflection of how the top marginal income tax rate has always compared to the top effective income tax rate. Furthermore, today we stand with a top income tax rate of 35%, the same rate as 2007, which is HALF of what the top rate was in 1979, but obviously the effective tax rate hasn’t seen that much of a change.
I can only profess to a cursory familiarity with our tax code, so this article isn’t about what kind of tax structures and rules have been employed over the past 70 or 80 years to keep the effective tax rate relatively stable. My point is that when we see these extremely high income tax rates in our textbooks and such they are NOT indicative of how much people actually paid in taxes. This is a clear explanation of how our economy wasn’t crippled by a 91% top income tax bracket, it simply didn’t exist. Why has federal revenue consistently been between 6-10% since the 1940’s? Because the federal government, as a ratio of our collective national economy, is collecting about as much in revenue through income taxes today as it did back then. We have a SPENDING problem, not a REVENUE problem…