So, this blog entry is a two part series where here I will discuss the top tax rates and the next post I will discuss whether lowering income tax stimulate growth or not. These are hotly debated issues.
So, to start, there is a little political cartoon being passed around on the internet titled, "Socialism: The top tax rate, a little historical perspective". It is clearly mocking those who think Obama's soon to be 40% top tax bracket is a big jump from today's 35%. However, this cartoon is an apples-to-oranges comparison because the top rate is only half the information. The other half of the information is what level of income that rate applies to. People probably assume, which is obviously the cartoonist's biased message, that the level of income that the top tax rate applies to has been the same throughout history. Also, what is not shown are the tax rates before the year the 77% rate took effect.
So, that's where I come in. I will give you some real perspective. So before we begin, let me remind you that the planned 2011 Obama 40% tax rate will apply to income over 200k (if the Bush tax cuts were extended, a 35% rate would still apply to income over 373k). And while this may seem like a lot to many people, it is not accounting for the cost of living for those who live in the largest cities in America, where a dollar goes about half the distance.
So, we will walk through a sample of the tax rates since the early 1900s. So, what you will notice is that the top tax rates are dropping, but so is the tax bracket, so that the top rate is affecting more and more of American's income.
Before 1914, taxes were sporadic which came and went depending on what war's debt needed to be paid off. The government collected most of its revenue with tariffs.
In 1914, the top tax rate was 7.0% on income over $500,000. After you adjust that for inflation (CPI) that 7% applies to income over $10,764,646. Okay, so then the 16th amendment was passed with the revenue act of 1916, and the tax rate doubled to 15% (gasp!). But that applied to income over $2,000,000 -that's $39,365,137 accounting for inflation. So over the next couple of years the tax rate increases dramatically until we find that 77% top tax rate that we see in the cartoon. That applied to income over $1 million, or $14,207,947 in 2009 dollars. So then the tax rate drops a little (the government has changed the tax code so many times you would think that they would have found the optimal solution by now). In 1922, the top tax rate drops to 58% on income over $200,000 ($2,554,047 accounting for inflation)... it continues to bob around and drop to 25% on income over 100,000 in 1925 ($1,225,942). In 1932 it jumps to 63% on income over $1 million. 1936: 79% on income over $5 million. 1941: 81% on income over $5 million.
1942 is a big year. The tax rate is raised to 88% on income over $200,000... but that's still $2,632,392 in 2009 dollars. Then in 1944 it was raised to 94% on the same bracket.
In 1964, top tax rate drops to 77% on income above $200,000, or $1,384,129 for 2009 dollars. 1965, 70% applies to $100,000 and above. Are you seeing a pattern here?
Taxes started to get really high during the inflationary period of the 1970s-1980s. For example, in 1981, 70% applied on $107,700 or $252,538. The US went through a period of stagnation around this time, and it is probable that excessively high tax rates played a role here, but many factors were at play.
1982: 50% on income over $42,800.
1983: 50% on income over $54,700.
The bracket grew over the next several years.
So, then we arrive in the modern era of tax rates in 1987. The top tax rate drops to 38.5% on income over $54,000 ($101,982).
2009 dollars from now on:
1988: top tax bracket of 28%, applying to income over $89,560.
1991: 31% on income over $51,900.
Clinton comes aboard and adds two top brackets, with the largest being 39.6 on income over $250,000.
2002: Enter Bush's tax policy: drops the tax rates down a few percent for each bracket, with the top 35% tax rate on income over $311,950
So what I left out was that today's era of tax brackets only have about 5 levels. Back in the olden days when there were tax rates above 40%, there were generally 15 or more tax brackets. And because of that, a better tax comparison would be to take a few samples of income levels (25k, 50k, 100k, etc) and calculate the actual tax bill in each year to get a better idea of what a hypothetical earner was actually paying and to determine which era had the largest burdens. Since this little analysis was already time consuming as it was, I don't plan on doing that here. But you can still clearly see that these "top rates" for most of America's history applied to income over a million. That is a stark contrast from today.
And let's not forget that this tax is only the federal income tax. When we tack on social security, Medicare, state, county, city, sales and sales tax [not to mention the million other taxes we end up paying (e.g. property taxes)], that 40% rate becomes 60% or more. Do you really think that the government is better at spending 60% of your money than you are?
How's that for some perspective?