There's No Going Back to the 1950s Tax System
The federal budget proposed by President Obama last week differs in details from the budget approved by Senate Democrats in March. But they both assume significantly higher effective tax rates on the wealthiest Americans.
The Senate envisioned fully $975 billion in new tax revenues to be raised over the next 10 years; the White House budget, $600 billion. That Democrats are comfortable targeting top earners can be understood, in part, as a product of a new piece of liberal conventional wisdom: The 1950s were a sort of golden age of economic growth and greater income equality—peacefully coexisting with high taxes.
Marquee liberals—including the American Prospect's Robert Kuttner ("let's restore the income tax schedule of the 1940s and 1950s, when the economy was booming and the rich paid their fair share of taxes") and the Center for American Progress's Michael Linden ("In fact, growth was actually fastest in years with relatively high top marginal tax rates")—champion that era's high corporate taxes and top marginal tax bracket of 91%. In doing so, they are popularizing research by University of California economists Thomas Piketty and Emmanuel Saez.
Nevertheless, a new study by Columbia University's Arpit Gupta "Revisiting the High Tax Rates of the 1950s," written for the Manhattan Institute, calls into serious question the notion that affluent Americans bore a higher tax burden than they do today.
True enough, the top marginal income-tax bracket after World War II and until the across-the-board cuts of 1964, was 91%. Yet very few people earned enough to pay that rate, which kicked in (for married couples) at $400,000, more than $3 million in current dollars. Moreover, the 25% capital gains tax as well as a variety of deductions and loopholes made the amount of income actually taxed at the highest rate vanishingly small.
These statements are hardly controversial. Indeed, in a 2007 paper, Messrs. Piketty and Saez note that the more progressive tax regime of the 1950s was "not mainly due to the individual income tax." Instead, it reflects the "corporate income tax and the estate tax."
Messrs Piketty and Saez did not reach their conclusion about the burden of corporate income taxes from a direct examination of tax returns. Instead, it stemmed from an estimate, drawn from a complex set of calculations and assumptions, about the corporate tax—which they said took 6.5% of total personal income in 1960 but much less, about 2.5% of total income, today.
Ultimately, Messrs. Piketty and Saez, concluded that the highest income groups paid an effective tax rate of 70%, a figure touted by New York Times columnist Paul Krugman and others. To reach their conclusion, however, they look beyond the income tax to corporate taxes and assume, crucially, that the entire burden of such taxes fell on stockholders, then predominantly wealthy, in the form of lower returns.
One problem with this calculation, as Mr. Gupta notes in his study, is that the burden of corporate taxation is also borne by employees in the form of lower wages. Mr. Gupta also points out that the corporate tax could not serve as a cash cow for a more "progressive" tax regime today. In the first place, thanks to globalization, domestic capital and corporate earnings are no longer a "captive" source of revenue that one nation can easily tax away.
In addition, stock owners now include many non-rich investors, not to mention the pension funds that hold capital in trust for millions upon millions of individuals and families of modest means. Higher taxes and lower returns on capital would hit them as well.
Mr. Gupta points out a third problem facing those who pine for a return to an imagined golden era of the high-tax-rate 1950s. It is not even clear that the tax regime of the 1950s was, taken as a whole, effectively more progressive than the present one.
Mr. Gupta notes that in 1970, Messrs. Saez and Piketty's own data demonstrate that the bottom 90% of Americans took home 67.6% of pretax income, but received 70.5% of income after taxes. In other words, the net impact of taxation on the distribution of income was to raise the income share of anyone not in the top-earning 10% of the population by 4.3%. Fast forward to 2004—after the Bush tax cuts. Now the "bottom" 90% took home 53.75% of income but received 57.28% after taxes. Their post-tax income share actually rose by 6.6%.
Advocates of higher tax rates often cite European nations as models of fairness. Yet to fund their welfare states, these countries typically have turned to broad-based taxes on consumption, such as the value-added tax. The VAT hits all consumers, not just the affluent.
Liberals don't need to be told this. Then-House Speaker Nancy Pelosi in 2009 said that a value-added tax should be "on the table." Without long-term spending reductions, it may have to be, to raise the sums Mr. Obama and Senate Democrats want.
This piece originally appeared in Wall Street Journal
This piece originally appeared in The Wall Street Journal