It is election season in the United States. The Republican Party’s “Big Idea” this year, as it has been since the 1980s, is that low top tax rates inspire the “job creators” to hire more workers and give them more pay. This “Big Idea” is, of course, a bald-faced and cynical lie. It is bald-faced because there is ample data to contradict it and it does not follow from analysis of the logic of the question. It is cynical, because this lie is hiding a fact that they refuse to grant: that what low income tax rates surely do is to advance the interests of the top 1% of wealth holders, even if that means that overall economic growth is held back as a result.
To get at the logical part, let’s consider the following question: “Imagine yourself a small business woman (a job creator in their parlance) who is deciding how much money to take out of her business for personal income. Let’s assume that she would be in the top income tax bracket. If the top income tax rate is 25%, as Mitt Romney and Paul Ryan proposed, would she have more incentive to keep that money in the business (grow the business and hire more workers) than if that rate were 75%? Remember that the tax rate applies to the money that she takes out of the business, not on the money that she keeps in.“
Once you have considered this question carefully, I think you will come to the conclusion that I have: The 75% rate gives much more incentive to the “job creator” to invest her small business income in the business, rather than to take that money out of the business and pay a high income tax. The 25% upper income tax rate, on the contrary, gives the incentive for the small business operator to take the money and run, since the income tax burden on money taken out of the business as personal income is so very low.
Now let’s consider the evidence. The graph above presents data on income growth since 1961 in the United States, compared with the top rate of income tax. The income data come from World Bank data on GDP. I converted annual income estimates in inflation-adjusted 2010 dollars to an annual rate of change. The income tax rate data are available from several sources. Full data have been presented by the National Taxpayers Union (History of Federal Individual Income Bottom and Top Bracket Rates). Since 1961 the average growth rate in average per capita income in the United States has been 5.5 percent. During the years when the tax rate was equal to or higher than 70%, from 1961 through 1975, the average per capita income growth was 6.2 percent. During the years when the top tax rate was less than 40 percent (from 1992 to 2007), the average per capita income growth rate was 3.6 percent.
Now let’s compare the data as a correlation. The graph above shows a reasonably good correlation coefficient, indicating a positive trend in income growth with increased top tax rate. Of course, there were a lot of factors that went into higher rates of income growth in the 1960s and 1970s, when the top tax rates were 70% or greater, than in recent years, when the tax rate has been successively lowered (almost exclusively by Republican administrations). But I think we can take this correlation as some evidence, at least, that the Republican’s “Big Idea” is false. And this analysis has been based on average per capita income. If one were to look at the median income, the situation would be worse for the working person because of the increase in inequality since 1980.
So much for the Republican Party’s “Big Idea” that low top tax rates inspire the “job creators” to hire more workers and give them more pay. By asking the question above we see the faulty logic of this. And the income growth statistics bear out this conclusion. Now let’s consider the cynical part. Why are the Republicans so interested in lowering the tax rate on top income earners, if it is bad for the national economy in general?
This last bit of the story is shown in the graph above: There has been a significant increase in inequality in proportion to the drop in the top income tax rates that we have seen under successive Republican presidents and Congressional majorities. These data come from studies by University of California sociology professor Willam Domhoff (Wealth, Income, and Power). After forty years of reduced tax rates (from the 70-95 percent that they were for forty years before) the proportion of US wealth held by the top one percent of wealth holders has gone nearly back up to where it was in 1929, before Roosevelt’s Congress raised the rates precipitously. The portion of the nation’s wealth held by the richest Americans in 1929 was about 44% when the top tax rate was 24%. The top rate rose to 63% during the thirties and 91% in 1945, and it remained over 70 % until 1976. By 1976 the portion of the nation’s wealth held by the 1% had fallen to 20%. High top rates succeeded in reducing wealth disparity. But then the Republicans took over. The top tax rate was lowered to as low as 28% during the Reagan years and to 31% in 1992. As we all now remember, Clinton raised the top rate to 40%, and then lowered it to 39%. Bush II lowered it to the current 35%, where it remains. By 1995 the wealth portion of the rich was back up to 39% and it has remained in that neighborhood since.
This graph shows this wealth data as a correlation. It shows an even stronger (negative) correlation between the wealth of the one percent and the top income tax rate than for income growth. There is a very clear correlation that promises good news for the one percent as the tax rate is lowered.
But what is the causation here? Does inequality cause low rates of growth because the top tax rates are too low? We have seen that poor income growth is correlated with low top income tax rates and we have seen that low tax rates are highly correlated with increasing concentration of wealth. As a final comparison, let’s plot the income growth and wealth concentration data together. The graph above shows these data as a time series. I don’t have income growth data prior to 1961, but for the comparisons after 1976, when I have data for both income growth and wealth concentration, we see that as wealth concentration increased in the post-Reagan years, income growth dropped significantly.
The final graph here shows income growth and wealth concentration as a correlation. Here we find the strongest correlation of all indicating that as concentration of the wealth increases income growth declines. This is a conclusion that makes sense. Poorer people spend relatively more of their income in the general economy than the rich. So increasing wealth concentration results in less overall economic activity and lower rates of growth in average incomes. So does increased inequality suppress economic growth? It appears that it does. Do lower top tax rates increase wealth concentration into the hands of the very well off. Yes, it it appears they do. And that is not such a difficult conclusion to understand. The only remaining question is why the US electorate would stand for this.
There is little question what is going on here in the Republican message: Lower the rate to fatten the one percent, even though this reduces not just wealth equality, but also overall economic growth in society. It doesn’t just grab more of the pie for the rich; it also reduces the overall growth rate of the pie. How has this been possible? Well, it seems to this reviewer that it has been possible because, regardless of the bad outcomes for the overall economy of low top income tax rates, the elites benefit famously. And they are able to control the process through their influence in Congress and by funding massive advertising and media campaigns to keep the electorate misinformed. This has accelerated with the Citizens United decision by a Republican-nominated Supreme Court.
So in conclusion: The “lower the top income tax rate to grow the economy” message, which is the Republican Party’s “Big Idea”, is a bald-faced and cynical lie. The question is not why we should raise the top rate to 39% again, as Obama has suggested, but why we should not raise it to 75%. I will leave that as another question for you to ponder.