Truth about Taxes   Leave a comment

In 1913, when the US federal income tax was first introduced, it was much simpler and easier to file taxes. Individual federal income tax rates started at 1%, with a maximum marginal income tax rate of only 7% on incomes above $500,000 (more than $12 million in today’s dollars). The personal exemption was $3,000 for individuals ($72,850 today) and $4,000 for married couples ($97,000 today). In other words, very few Americans pad to pay federal income tax since the average income in 1913 was only about $750. You can look this up yourself here.

Related imageWhat your visit to that chart will show is that taxes didn’t stay so low. It only took a few years for the government to raise the income tax substantially. The top marginal rate was 67% in 1917 and 2% for anyone making over $2,000.

Wilson’s administration of tax and spend was replaced by President Warren Harding, which ushered in Calvin Coolidge’s reformations of cutting government spending and lowering tax rates. Coolidge saw these as moral issues:

securing greater efficiency in government by the application of the principles of constructive economy, in order that there may be a reduction of the burden of taxation now borne by the American people. The object sought is not merely a cutting down of public expenditures. That is only the means. Tax reduction is the end.[i]

He described excessive taxation as “nothing more or less than a restriction upon the freedom of the people.” Coolidge understood that the task of spending and tax reduction was a “gigantic task” for his administration, but he argued:

We are seeking to let those who earn money keep more of it for themselves and give less of it to the Government. This means better business, more of the comforts of life, general economic improvement, larger opportunity for education, and a greater freedom for all the people. It is in essence restoring our country to the people of our country. It re-endows them not only with increased material but with increased spiritual values.[iv]

Tax rates during the 1920s had already started to be lowered by President Harding, but it was also important to lower government spending at the same time. Coolidge believed in a limited government and rejected the progressive philosophy that argued for a larger central government managed by an administrative regulatory bureaucracy. Coolidge believed that this was unconstitutional. “Government extravagance is not only contrary to the whole teaching of our Constitution, but violates the fundamental conceptions and the very genius of American institutions,” noted Coolidge.[v]

 

Coolidge lamented the efforts to abandon limited government and traditional federalism and he argued that ultimately the people must solve this problem. As he stated:

The cure for this is not in our hands. It lies with the people. It will come when they realize the necessity of State assumption of State responsibility. It will come when they realize that the laws under which the Federal Government hands out contributions to the States is placing upon them a double burden of taxation — Federal taxation in the first instance to raise the moneys which the Government donates to the States, and State taxation in the second instance to meet the extravagances of State expenditures which are tempted by the Federal donations.[viii]

 

Historian Burton W. Folsom, Jr. wrote that Coolidge “lowered tax rates, cut federal spending, and had budget surpluses every year of his presidency.”[x] In addition, Coolidge “finished his second term with the lowest misery index (unemployment plus inflation) of any president in the last one hundred years,” noted Folsom.[xi]

As a result of Coolidge’s budget and tax polices it unleashed a period of economic growth and expansion. It also resulted in low unemployment and an increase in the standard of living for the middle-class. Under Coolidge the federal budget fell to $3 billion in 1928 from over $5 billion in 1921.[xii] The Coolidge tax cuts also lowered tax rates and helped the business expansion which occurred during the 1920s.

Coolidge was replaced by the pro-spending and pro-taxation administrations of Hoover, FDR, Truman and Eisenhower when everybody paid between 20-91% of their income in taxes. Eisenhower reacted to the recession following the Korean War Armistice by cutting military spending significantly. Congress further reduced the budget overall. These led to increased growth in the private sector, but since taxes weren’t cut also, the economy took a sharp downward turn in 1958.

Starting in 1961, Democratic President John F. Kennedy initiated pro-growth tax reduction policies and achieved results comparable to Coolidge’s. When Kennedy took office as president in January 1961, the highest and lowest federal marginal personal income tax[R1] rates were 91 percent and 20 percent. Kennedy’s tax program cut those rates to 70 percent and 14 percent. Kennedy also cut the corporate income tax rate and the tax rates on capital gains, reduced taxes on dividends, and balanced the federal budget.

“It is a paradoxical truth,” Kennedy stated in 1963 at the Economics Club of New York, “that tax rates are too high today and tax revenues are too low, and the soundest way to raise the revenues in the long run is to cut the tax rates.”

Fueled by pro-growth economic policies, the GDP growth rate averaged 4.4 percent per year from 1960 through 1969, the highest yearly growth rate per decade from 1950 to 2000. Correspondingly, the 5.5 percent US unemployment rate in 1960 dropped to a 3.5 percent rate by 1969.

Ronald Reagan sought to reduce income tax burden during his presidency. In his autobiography, An American Life, he explained “[M]y major was economics. But I think my own experience with our tax laws in Hollywood probably taught me more about practical economic theory than I ever learned in the classroom or from an economist.”

From firsthand experience, Reagan understood the links between work, taxes, and incentives:

At the peak of my career at Warner Bros., I was in the 94 percent tax bracket; that meant that after a certain point, I received only six cents of each dollar I earned and that the government got the rest. The IRS took such a big chunk of my earnings that after a while I began asking myself whether it was worth it to keep on taking work.

Something was wrong with a system like that, asserted Reagan:

When you have to give up such a large percent of your income in taxes, the incentive to work goes down. You don’t say, ‘I’ve got to do more pictures.’ You say ‘I’m not gonna work for six cents on the dollar.’

Reagan saw how confiscatory taxes at the top negatively impacted people in lower income groups:

If I decided to do one less picture, that meant other people at the studio in lower tax brackets wouldn’t work as much either; the effect filtered down, and there were fewer jobs available. I remember one scene in the Knute Rockne picture that had only a farmer and a horse in it on location that created work for 70 people.

In August 1981, Reagan signed the Economic Recovery Tax Act into law, slashing marginal income tax rates by 25 percent across the board over a three-year period. The highest marginal rate on unearned income dropped from 70 percent to 50 percent. The tax rate on capital gains fell from 28 percent to 20 percent.

By January 1983, the bulk of Reagan’s tax reductions were in place. With higher incentives to work, invest, and produce, the consequences were foreseeable. Between 1978 and 1982, the US economy grew at a rate of only 0.9 percent in inflation-adjusted terms. From 1983 to 1986, this growth rate shot up to 4.8 percent. The national unemployment rate dropped from 9.7 percent in 1982 to 5.5 percent by 1988.

Economist Stephen Moore summarized how economic growth and tax revenues increased under the tax cut policies of Reagan and Kennedy:

Many times, tax rate cuts – including in the 1960s under John F. Kennedy and in the 1980s under Mr. Reagan – have raised tax revenues from the wealthiest tax filers because lower rates reduce incentives for tax avoidance and recharge the batteries of the economy and grow taxable incomes.

In both the 1960s and 1980s, supply-side tax cuts were followed by increased revenues. As Larry Kudlow puts it in his soon-to-be-released book on the JFK tax cuts: ‘We had six percent growth and the tax payments by the wealthiest filers nearly doubled. We had quarters of six percent growth back then.’ After the Reagan cuts, the share of taxes paid by the top 1 percent rose from 19 percent in 1980 to above 25 percent in 1988, according to IRS tax return data.’

Moore drew parallels between the Kennedy and Reagan economic successes and President Trump’s proposed tax reforms: “The heart of the Trump tax plan is to cut our business tax from the highest in the world down to 15 percent, making our rate one of the lowest. This will reverse the stampede of businesses fleeing out of America,” generating domestic job growth.

“Small businesses – the backbone of our economy – will benefit too,” wrote Moore, regarding Trump’s tax proposal. “Their tax rate falls from close to 40 percent to 25 percent, because business owners pay taxes at the personal income tax rate. This will allow companies to invest more and hire more workers here at home.”

 

 

 

The bottom line about taxes, incentives, GDP growth, and government debt? “The biggest deficit we need to urgently fix is our growth deficit,” contends Moore.

We must pump up our GDP growth from the anemic one percent rate of Mr. Obama’s last six months up to a sustained 4 percent for five to 10 years. Here are some amazing statistics from the Congressional Budget Office. If you raise the growth rate by one percentage point over one decade it reduces the budget deficit by $3 trillion. If Mr. Trump can juice growth from 2 to 4 percent then poof, federal borrowing disappears by $6 trillion. Liberal economists pout that this kind of growth is impossible for America, but that’s what people said in the miserable 1970s, but Mr. Reagan (and JFK before him) proved that with the right policy incentives that get government off the back of business, a new era of prosperity is just around the corner.

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Posted May 15, 2017 by aurorawatcherak in economics, Uncategorized

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