Bruce Bartlett offers a fine economic history lesson on the U.S. top marginal tax rate. Most people know that the top rate has changed quite a bit over time. (For those keeping score: 91% from WW2 to the early 1960s; 70% till the early 1980s; 50% for most of the Reagan administration; 28% in the late 1980s; raised to 31%, then 36%, then 39.6% in the early 1990s; lowered to 35% in 2001). Bartlett compares the top tax rate with the economic growth rates during those intervals and finds basically no correlation. That, too, is not really news (and a more careful study would take other factors into account).
What is striking, however, is how the threshold level of income for the top rate has changed over time. The original income tax, at the height of the Progressive Era during the Wilson administration, set the threshold at $500,000, which is not only higher than today’s $374,000 but was in 1913. The price level has increased more than 20 times since then; adjusting for inflation, the 1913 top tax rate kicked in at $11 million.
The famous tax cuts engineered by Harding-Coolidge-Hoover Treasury Secretary Andrew Mellon in the 1920s lowered that threshold considerably (to $100,000, or $1.2 million in today’s dollars) but in real terms left it still well above today’s. Pres. Franklin Roosevelt raised both the top tax rate and the threshold to sky-high levels (79%, and a threshold that would be $80 million in today’s dollars and may have only affected one person; some called it “the Rockefeller tax”). The threshold fell to $200,000 (equivalent to about $3 million today) during WW2 and basically stayed there till the early 1980s. The “Reagan tax cuts” of 1981 lowered the threshold to $85,600 (not quite $200,000 today). The Tax Reform Act of 1986, which Reagan signed, flattened the tax system further, with a top rate of 28% that kicked in at just $30,000 (about $50,000 today). The “Clinton tax increase” raised the threshold from $86,000 to $250,000, and inflation adjustments have raised it to $374,000 today.
Notice a partisan pattern here? It’s no secret that Republicans think the rich are overtaxed and Democrats think the rich are undertaxed, but the discussion almost always focuses on the top tax rate. What’s often missing is just where the definition of “rich” begins. In the historical record, Democrats (Wilson, Franklin Roosevelt, Clinton) have tended to set the top tax threshold high, whereas Republicans (Harding, Reagan) have tended to lower it. Much of this comes down to different notions of fairness: Democrats tend to favor a progressive income tax in which richer people pay a larger share of their income and poor people pay little or none; Republicans tend to favor a flat income tax (or no income tax), in which everyone pays the same marginal rate. Having the top rate kick in at very high levels of income tends to go hand in hand with a multiplicity of different tax rates and a highly progressive tax structure, whereas having it kick in at low levels of income means a much flatter tax.
Ever since the “Bush tax cuts” of 2001 were passed, many Democrats have talked about raising the top tax from 35% back to 39.6%, but until recently I’d heard surprisingly little talk about raising the threshold.This was surprising to me, because, as Bartlett points out, many people do not regard $250,000 or even $374,000 as particularly rich — at least not if, say, you live in New York City and have a family of four. It’s rather unclever politics to talk about raising the top rate without reassuring upper-middle class people that you’re not going to raise their taxes too. Republicans, with clever simplicity, typically truncate “tax increase on the wealthy” to “tax increase,” implying that it’s a tax increase on everybody. Lately Pres. Obama has called for raising the threshold to $1 million, so that people making $374,000-$999,999 would still pay 35 cents on their last dollar of income but people would pay 39.6 cents on every dollar of income above $1 million.
It is still debatable whether raising anyone’s taxes in a depression is ever a good idea, but ideally whatever major long-term deficit reduction plan Congress passes will go into effect only when recovery is well underway and unemployment is down to, say, 7% or less. When that happens, I agree with Bartlett that raising revenues efficiently and equitably will entail raising taxes on the top brackets (either through raising rates or, better yet, closing loopholes) and raising the top tax threshold.