
In my latest OLLI talk, “Economic Growth: Crucial but Uncertain,” which I posted and talked about on Substack, I didn’t discuss one question that one of the participants asked. I didn’t think to do so because John, the A/V guy, made certain cuts and, for some reason, that question and my answer aren’t on the video.
I took the audience on a quick tour of the top marginal rates through the 20th century: from 7% when the first income tax was implemented; to 77% under Woodrow Wilson; down to 25% under Treasury Secretary Mellon (working his way down in the Harding and then Coolidge administrations; up to 63% under Herbert Hoover then 79% during peacetime FDR and up to 94% during the last part of the war under FDR; then down to 91% for most of the 1950s and early 1960s; then down to 70% under LBJ (as part of the Kennedy tax cut); then down to 50% early in the Reagan administration and 28% late in the Reagan administration; then up to 31% under George H.W. Bush; etc.
Of course I gave a more summary statement than the above, but the audience got the point.
One of the audience members, a guy named Ed, said, “Don’t the high marginal tax rates in the 1950s mean that high tax rates don’t matter that much for economic growth since growth was pretty good in the 1950s?”
I answered that the highest marginal tax rates kicked in at a very high income level and that one needed to adjust for inflation to see how irrelevant they were for over 90% (and probably over 95%) of income earners. (I’m using “earner” in the broad sense; if I own stock that gave me a handsome dividend income, I count that income as earned.)
I could have given a better answer if I had had the data handy, and I’m about to do that. But I completely left out another answer: the economy was much less regulated in the 1950s than now. It was much easier to get a permit to build a house, a bridge, a pipeline, an office building. Also the liability revolution that Walter Olson has written about so well had not yet happened, so that producers didn’t have to waste a lot of effort on idiot-proofing their products. Etc. All those positives can easily upset the negatives of high marginal tax rates for a small percentage of the population. (One caveat: we didn’t have deregulation of airlines, trucking, or railroads and that did hurt somewhat.)
Now to the data on taxes. The Tax Foundation gives the data on tax brackets and tax rates from 1862 to 2021 here.
Look at the marginal tax rates for 1954. For married couples filing joint, if you had $400,000 or more in taxable income, your marginal tax rate was 91%; for singles, it kicked in at $200,000. That rate with the same income brackets was the same from 1954 to 1963.
But $400,000 in 1954 was $4.66 million. Moreover, the whole real income distribution is higher now, probably at least twice as high. So that would be like imposing a 91% marginal tax on a married couple with $9.32 million in taxable income.
To be sure, marginal tax rates were well above today’s rates even for much lower incomes. Consider 1954 again. For a married couple with taxable income of $24,000, the marginal tax rate was a whopping 43%. In today’s dollars, $24,000 would be $280,000. So my point is not as strong as I originally thought. On the other hand there were no Medicare taxes and Social Security tax rates were much lower. In 1954, the combined SS tax on employer and employee was 4%, versus 12.4% now. Moreover, it was zero after an income of $2,400, which is $28,000 in today’s dollars.
Here’s my speculation, although I don’t have time to do the math and check a lot of data. Up through 1963, for over 80% of U.S. taxpayers in the top half of the income distribution, marginal tax rates, including Social Security and Medicare, were lower than they are for over 80% of taxpayers in the top half of the income distribution today.
READER COMMENTS
Fazal Majid
May 23 2024 at 8:49am
And of course the ultra-rich don’t get their earnings in the form of salaries but capital gains that are taxed at a much lower rates. Who would actually be paying the headline rate other than actors and sports stars?
Ahmed Fares
May 23 2024 at 4:06pm
Capital gains come from retained earnings, which have already been taxed when earned before dividend distributions. This brings up the issue of double taxation.
If we assume that a company sells at twice book value, then each dollar of retained earnings which adds to book value will cause a two dollar increase in the share price. This suggests that an inclusion rate on capital gains of 50% is about right. That taxes that extra dollar which hasn’t already been taxed.
Matthias
May 26 2024 at 3:58am
Most publicly traded companies have price / earnings ratios a lot higher than 2.
Ahmed Fares
May 26 2024 at 5:01am
My comment said price to book, not price to earnings.
Matthias
May 26 2024 at 4:08am
Of course, the main reason rich people take capital gains instead of other forms of income is the very fact they capital gains are typically taxed less.
Compare also the buy-borrow-die strategy, where people turn their capital gains into consumable income by borrowing against their equity, instead of selling any. Because unrealised capital gains are typically completely untaxed.
If tomorrow personal income were to be taxed less than (unrealised) capital gains, you can bet your head the rich would report lots of personal income instead.
Jose Pablo
May 26 2024 at 10:08pm
Any invested capital has already been taxed. To “invest” you first need to “earn” (an activity that is taxed), then “save” part of your already taxed earnings, and then “invest” your savings.
Investing as a way of minimizing taxes is a totally non-sensical strategy. If you want to minimize the total amount of taxes paid, the most sensible strategy is to expend all the money you earn.
steve
May 23 2024 at 11:07am
So really high marginal rates on that top 20% wont inhibit growth? Tax the rich! (Appreciate your quick stab at this as it’s a complicated issue. You leave out capital gains as noted above and state and local taxes and maybe more importantly what taxes they actually paid. Having spent a lot of hours looking at these numbers I have come to the conclusion, maybe wrong, that tax rates and taxes paid have only minor effects on growth and productivity. Other factors like culture, education, natural resources, infrastructure and regulations seem to matter a lot more. Probably have some effect at the extremes but then taxes actually paid rather than rates seems more important.)
Steve
Craig
May 23 2024 at 1:44pm
“I have come to the conclusion, maybe wrong, that tax rates and taxes paid have only minor effects on growth and productivity. ”
Let’s take a quick look at defense spending because I ran some numbers on those and in the US current per capita spending on defense is approximately $2000 per capita. One can say that if the US weren’t such a war mongering nation and spent far less on defense per capita, say the US govt spent the same amount per capita as Canada, well, then I’d still have that money, you know, from 1986, year after year after year. And looking back now I can hypothesize that I could’ve invested that money in my own business or even just the S&P and I’d have 7 figures off that. Instead ‘we’ have the USS Gerald Ford, a $20bn colossus. Last I checked I don’t see Gavin MacLeod waving to me from the Love Boat inviting me on board either. Of course killing and destroying things is the federal government’s specialty, they’re really good at it. Now I suppose from a macro point of view that aircraft carrier counts as GDP.
“So really high marginal rates on that top 20% wont inhibit growth? Tax the rich!” {emphasis supplied}
In the 1950s NJ ddn’t even have a state income tax yet. Indeed in the 1950s there were a few marginal RATES that were high, but overall aggregate taxation at all levels of government for the vast majority of people was much lower and that includes social security too.
steve
May 24 2024 at 11:20am
Sure, or Canada invades us and takes all of our good stuff. Actually, they are too nice so pick someone else.
Steve
David Henderson
May 26 2024 at 3:12pm
It’s not the top 20%. It’s the top 10%. Note what I said: “Up through 1963, for over 80% of U.S. taxpayers in the top half of the income distribution, marginal tax rates, including Social Security and Medicare, were lower than they are for over 80% of taxpayers in the top half of the income distribution today.”
80% of 50% is 40%. That leaves the top 10%.
Jason Sorens
May 23 2024 at 11:08am
Also, income tax deductions for high earners were far more generous then than now. https://www.aier.org/article/the-rich-never-actually-paid-70-percent/
Ahmed Fares
May 23 2024 at 3:50pm
re: personal tax incidence
Getting Tax Burden Wrong – David Friedman
Ajit Kirpekar
May 23 2024 at 5:51pm
I believe Ragu Rajan wrote an article on ft times showing that through the use of loopholes and income reclassification, almost none of those high incomes actually had to pay those marginal tax rates.
I believe if you look at the share of tax revenue paid by the top 1% or top 10%, it’s been remarkably stable over time – right through and including the sky high tax rates of the 50s and 60s.
Mike Burnson
May 25 2024 at 10:27am
Hello to all! I think that what is missing from virtually all of these 1950s tax comparisons is the very nature of the global economy then compared with today. Europe and Japan were still rebuilding from WW II and foreign competition was very limited. Additionally, energy prices were far lower; regulatory costs were a fraction of today’s economic climate. We were also paying down the debt incurred during WW II, so high taxes were accepted by the American public for a known, legitimate expense. It is challenging to even compare incomes between today and 70 years ago.
It is frequently argued (though I stay out of this arena) that the high tax rates were deliberately intended to prevent an over-juiced economy. Hmmm.
Matthias
May 26 2024 at 4:00am
High tax rates don’t prevent inflation.
Of course, they might have been intended to. But they didn’t.
Joy Schwabach
May 26 2024 at 12:38pm
Fascinating, thank you!
David Henderson
May 26 2024 at 3:13pm
You’re welcome, Joy. I loved your story you told about Milton on David Friedman’s recent post about his father. That’s the man I knew.
Jose Pablo
May 26 2024 at 10:02pm
The whole argument misses the most tricky part of counterfactuals. We really don’t know what the growth rates would have been in the 50s with much lower marginal tax rates.
diz
May 28 2024 at 4:56pm
If a high marginal tax rate is the key to prosperity let’s set the to rate to 2487% on incomes about $55 trillion and let the good times roll.
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