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Many people have heard of art history. Today’s Straight Talk will be about tax history. I know what some of you may be thinking. How boring. But in today’s fiscal cliff and tax uncertainty, history can be a guide.
World War II. The war to end all wars. To finance the war the government had to borrow which it does by issuing Treasury securities. And by the end of the war, the debt of the government swelled from 39 billion to $251 billion or 112% of GDP at its conclusion in 1945. In case that one got by without notice, 112% of GDP means that the government owed more money than the entire country could make. So what happened in taxes to fix this problem.
Top income tax rates were changed as follows:
1944= 94% on income over $200,000
1946= 91% on income over $200,000
1956- 1962= 89%
Finally by 1964 the rate started coming down to 76% and in the 1970’s and 1980’s went into the 50% category. I wasn’t working yet but I remember my parents talking about how much money was lost to taxes and how hard one had to work to make a good living.
Adjusted for inflation these top brackets in 2011 would apply to incomes over 2.3 million, eventually being lowered to over $500,000.
During the Regan era as tax rates continued to go lower the threshold of income subject to tax also dropped to just over $100,000. As rates dropped, they also lowered how much money you could make but would still have to pay tax. So even though more and more people were subject to tax, they paid that tax at a lower rate. One can attach one’s own meaning to this concept. In the author’s view, more and more people subject to tax albeit at a lower rate means more revenue for the government and I believe this is eventually how the country ended up in surplus during the Clinton years.
According to a Wall Street Journal article dated December 7, 2012, in 1958, the top 3% of taxpayers earned 14% of all adjusted gross income and paid 29% of all taxes, while in 2010, the top 3% earned 27% and paid 51% of all taxes. What is important to understand is that only 236 of the nation’s 45 million filers back in 1958 actually paid tax at the highest rates so having a 91% rate was somewhat illusory. However, what is more important is that in looking at the number of Americans paying taxes in the 33% bracket, back in 1958, the number was less than 1 percent and they paid about 6% of all taxes while today the number is about 2.75% but they pay almost 50% of the taxes.
In contrast, according to the article, the bottom two-thirds of taxpayers saw their income tax responsibility drop from 29% to just 6% on incomes that went from 41 to 22 percent. Today, almost one-half of filers pay no tax and actually receive a refund from the government which means that the people who pay taxes are now working to give money to those who don’t.
This tax history is important in the discussion of how tax rates and tax deductions affect economic behavior. When tax rates are high and people are allowed artificial tax deductions they invest in all kinds of schemes to lower their taxes that aren’t necessarily good economic investments. As tax rates come down and the tax deductions are eliminated the opportunity to make real top line revenue is encouraged. Growing top line revenue is what makes a business or person more wealthy and when taxes are less on that top line revenue you get to keep more of what you make. Make money. Keep money. When that happens everyone benefits.
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