INCOME TAX RATES: AN HISTORICAL PERSPECTIVE

Here’s issue #7 of my Policy and Politics Newsletter, written 11/27/11. As you probably know, the Congressional Super Committee failed this week to reach an agreement on a recommendation for reducing the federal deficit. One of the key sticking points was income tax rates. The Republicans insisted on reducing income tax rates along with reducing some deductions, while the Democrats refused to lower tax rates for the wealthy and supported rolling back the Bush cuts in tax rates for the wealthy.

The federal income tax went into effect in 1913. The income tax rates have always been progressive, meaning that the tax rate for lower income tax filers has always been lower than the rates for higher income filers. The rates are much less progressive today than they have been historically and they have been simplified by reducing the number of steps between the lowest rate and the highest.

A summary of federal income tax rates: [1]

During most of the post World War II economic boom in theUS(1946-1964), the wealthy paid at a 91% rate while the lowest income filers paid at 20%. For the next 18 years, the wealthy paid at a 70% or higher rate while the lowest income paid at roughly 15%. Since then the rates for the wealthy have been reduced dramatically. The threshold for paying the top rate has been between $200,000 and $400,000 of income since 1964.

Note that if your taxable income is $1 million, a 1% rate reduction reduces your taxes by $10,000. If your taxable income is $50,000, a 1% rate reduction reduces your taxes by $500.

The argument typically advanced for reducing tax rates for the wealthy (or for not increasing them) is that if they have more money they will invest it and that, therefore, the economy will grow, jobs will be created, and everyone will be better off. However, in the 1990s, when President Clinton increased income tax rates on the wealthy, the economy performed very well. And in the 1980s and the 2000s, when tax rates were cut, there was no economic boom. Furthermore, over the last 30 years, as the income tax rates for the wealthy have been cut in half, income inequality in the US have widen considerably and middle and low income households have seen very little growth in their incomes (see newsletter #4, 11/13/11).

In summary, both the performance of the economy and changes in household incomes over the last 30 years do not support the argument that cutting income taxes for the wealthy will lift all boats, trickle down to middle and lower income households, or stimulate the economy.