The question of whether to extend the Bush tax cuts seems hopelessly mired in misinformation. The bickering in Washington on the economy seems almost exclusively focused on the top marginal tax rates — the rate paid by the wealthiest taxpayers on the income that falls into their highest tax bracket. The little mentioned fact is that everyone, including millionaires and billionaires, pays income taxes at the same marginal tax rates.
To begin with, we all pay taxes only on “taxable income.” That means we all get personal exemptions for dependents, itemized deductions or the standard deduction, and any applicable tax credits or preferences. We then pay taxes on the “taxable income” that’s left, and we all pay taxes at the same marginal rates on our taxable income.
Using married, filing jointly as an example, we will all for the tax year 2010 pay:
10 percent on the first $16,500 in taxable income,
15 percent on the amount over $16,750 up to $68,000,
25 percent on the amount over $68,000 up to $137,300,
28 percent on the amount over $137,300 up to $209,250,
33 percent on the amount over $209,250 up to $373,650, and
35 percent for all taxable income over $373,650.
The Obama administration’s proposed repeal of the Bush tax cuts would mean marginal rates would be increased for the portion of taxable income above $200,000 for individuals and $250,000 for families. The proposed increases would be from 33 percent to 36 percent, and from 35 percent to 39.6 percent, for the two highest tax brackets.
When you look at this proposed increase in marginal rates on taxable income, the thing we need to understand is that, in relative terms, all of these rates are quite low historically. Back in 1913, when the income tax was first proposed, the highest marginal tax rate was initially only 7 percent. This was quickly raised to 15 percent in 1916, and then escalated rapidly to a top rate of 77 percent in 1918.
During the 1920s, the top rate was reduced back down to 25 percent for income above $100,000 and stayed at that lower rate through the Stock Market Crash of 1929 and into the early 1930s. President Roosevelt increased spending and raised marginal tax rates in 1932 including marginal rates of 56 percent to 63 percent for income above $100,000. Tax rates remained high through World War II, peaking at 94 percent in 1944 for taxable income above $200,000.
Rates remained high until President Kennedy lowered marginal tax rates to 70 percent on income over $200,000 for married couples and $100,000 for individuals. Tax rates remained at this level until President Reagan lowered them during the 1980s. By the end of his second term, Reagan had lowered the highest marginal tax rates to 33 percent. President Clinton raised the top rates back up to 36 and 39.6 percent for the top two tax brackets, and President George W. Bush lowered these top two brackets back down to 33 and 35 percent where they remain today.
What’s important to note is that marginal tax rates have had little to do with the economic well being of the American people. Low marginal tax rates did nothing to head off the Great Depression, and top rates ranged from 70 to 92 percent during what was considered the golden age of American capitalism from the end of World War II until the early 1970s.
President Kennedy was credited with spurring economic growth in the 1960s by lowering rates and his example was frequently cited during the Reagan and George W. Bush years to justify further reductions in marginal tax rates. The correlation between these most recent reductions in marginal rates and economic growth is tenuous at best, especially the cuts by Reagan in his second term and those of George W. Bush. Reagan and Bush tax cuts did very little to promote economic growth — what they did accomplish was an upward spiral of US national debt.
In the context of current economic conditions, the greatest threats to economic growth are not small increases in the top marginal tax rates. Businesses large and small do not hire more workers in response to small changes in marginal tax rates. They hire workers to expand their businesses in response to increased demand for the goods and services they produce. And both businesses and individuals need access to capital to invest and spend.
Businesses and individuals reduced spending starting in 2008 as the stock market tanked and the housing bubble burst. The federal government stepped in to prop up demand and restore liquidity to the capital markets without which we would likely have experienced a depression as bad or worse that the Great Depression of the 1930s.
The American economy is growing again but with anemic demand for goods and services and the resulting job creation has been very slow — too slow to put many millions of Americans back to work. Putting Americans to work will ultimately increase the demand for goods and services as millions re-enter the workforce and is the only way to get the American economy back on track.
There is a recent precedent for raising marginal tax rates in circumstances like we face today. President Clinton in 1993 raised the top marginal rate from 33 percent by creating two new 36 percent and 39.6 percent tax brackets, while at the same time constraining the growth of federal spending. Constrained growth in federal spending, and increases in federal revenues slowly lowered the federal deficit and the federal claim on capital in the capital markets. This led to a decade of prosperity that produced 22 million jobs, actual federal budget surpluses, and future year budget surplus projections in the trillions of dollars. Reducing the government’s share of available capital meant more capital available for businesses and individuals.
The big lie on jobs and taxes is that lower marginal tax rates on the wealthiest Americans create jobs. They don’t. Macroeconomic policy, both monetary and fiscal, are the only tools we have found that can be used to steer a capitalist economy. Which leaves us with the conclusion that all those who today focus on keeping the Bush-era marginal tax rates must have a different agenda than what’s good for the American economy and the American people.
A purposeful and ideologically-based interest in defunding the federal government is one explanation. Self-interest is another. The problem is that in the long run an American economy saddled with both public and private debt won’t have the capital to invest and compete in a growing world economy. The tax-rate hawks are engaged in a very short-sighted and unenlightened view of self-interest.
The very real threat we face in the world economy can’t be fixed by tinkering with marginal tax rates. We can only position ourselves for success the old fashioned way — by spending less on what we don’t need, and getting out of debt while saving and investing for the future. Government can and must lead the way by curbing unnecessary spending and raising sufficient revenues to balance its books over time, meet the needs of the less fortunate, pay for what the American people need to live comfortably and securely, and invest for our nation’s future.