A very distinct pattern has been observable throughout American economic history: When tax rates are reduced, the economy’s growth rate rises, government tax revenues increase, and living standards improve across all of society. Conversely, periods of higher tax rates are associated with sub-par economic performance and stagnant tax revenues. Veronique de Rugy of the Cato Institute explains:
“Changes in marginal income tax rates cause individuals and businesses to change their behavior. As tax rates rise, taxpayers reduce taxable income by working less, retiring earlier, scaling back plans to start or expand businesses, moving activities to the underground economy, restructuring companies, and spending more time and money on accountants to minimize taxes. Tax rate cuts reduce such distortions and cause the tax base to expand as tax avoidance falls and the economy grows.”
An examination of the four major instances of U.S. tax-rate reductions illustrates the point.
(1) The Tax Cuts of the 1920s
When the federal income tax was enacted in 1913, the top rate was just 7 percent. In 1917 and 1918, tax rates were increased dramatically at all income levels; by the end of World War I, the top rate stood at 77 percent. America’s real Gross National Product (GNP) fell by 16 percent between 1919 and 1921.
Then, behind the leadership of Treasury Secretary Andrew Mellon — who served in both the Warren Harding and Calvin Coolidge administrations — tax rates were cut sharply under the Revenue Acts of 1921, 1924, and 1926. Mellon explained his rationale:
“The history of taxation shows that taxes which are inherently excessive are not paid. The high rates inevitably put pressure upon the taxpayer to withdraw his capital from productive business and invest it in tax-exempt securities or to find other lawful methods of avoiding the realization of taxable income. The result is that the sources of taxation are drying up; wealth is failing to carry its share of the tax burden; and capital is being diverted into channels which yield neither revenue to the Government nor profit to the people.”
As a result of the Mellon tax cuts, federal government revenues derived from personal income taxes rose from $719 million in 1921 to $1.164 billion in 1928, an increase of more than 61 percent. Between 1922 and 1929, America’s real GNP grew at an average annual rate of 4.7 percent, and the unemployment rate fell from 6.7 percent to 3.2 percent.
Notably, as tax rates were reduced, the share of the tax burden paid by the rich (those earning $50,000 or more in those days) rose from 44.2 percent in 1921 to 78.4 percent in 1928. Moreover, taxes paid by people earning in excess of $100,000 soared from roughly $300 million to $700 million per year.
(2) The Kennedy Tax Cuts of the 1960s
After Herbert Hoover had dramatically increased tax rates in the early 1930s, and Franklin Roosevelt had pushed marginal tax rates to more than 90 percent, President John F. Kennedy recognized that high taxes were hindering the U.S. economy. To remedy the situation, he proposed across-the-board tax-rate reductions; the top tax rate, for example, was slashed from 91 percent to 70 percent. Said Kennedy:
“Our true choice is not between tax reduction, on the one hand, and the avoidance of large Federal deficits on the other. It is increasingly clear that no matter what party is in power, so long as our national security needs keep rising, an economy hampered by restrictive tax rates will never produce enough revenues to balance our budget just as it will never produce enough jobs or enough profits…. In short, it is a paradoxical truth 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 rates now.”
As a result of Kennedy’s tax cuts, the federal government’s tax revenues climbed from $94 billion in 1961 to $153 billion in 1968, an increase of 62 percent (33 percent after adjusting for inflation).
Moreover, in a manner similar to what had occurred in the 1920s, the share of the income-tax burden borne by the rich increased following the Kennedy tax cuts. Tax collections from those earning more than $50,000 per year climbed by 57 percent between 1963 and 1966, while tax collections from those earning below $50,000 rose by just 11 percent. Consequently, high earners saw their portion of the income-tax burden climb from 11.6 percent to 15.1 percent.
(3) The Reagan Tax Cuts of the 1980s
After the inflation of the 1970s had pushed millions of Americans into higher tax brackets (even though their inflation-adjusted incomes were not rising), President Ronald Reagan took office and promptly proposed sweeping tax-rate reductions. The cornerstone of his economic policy was a 25-percent across-the-board tax cut, enacted in 1981. According to then-U.S. Representative Jack Kemp (R-NY), one of the chief architects of the Reagan plan:
“At some point, additional taxes so discourage the activity being taxed, such as working or investing, that they yield less revenue rather than more. There are, after all, two rates that yield the same amount of revenue: high tax rates on low production, or low rates on high production.”
As a result of the Reagan tax cuts, total federal government revenues climbed by 99.4 percent during the 1980s. The average annual growth rate of America’s real Gross Domestic Product (GDP) from 1983 to 1989 was 3.8 percent per year, compared with 2.8 percent from 1974 to 1981. By the end of the Reagan years, the American economy was almost one-third larger than it had been when they began. From 1981 through 1989, the U.S. economy produced 17 million new jobs, or roughly 2 million new jobs each year.
Also, the share of income taxes paid by the top 10 percent of earners jumped significantly, climbing from 48.0 percent in 1981 to 57.2 percent in 1988. The top 1 percent of earners saw their share of the income tax bill climb even more dramatically, from 17.6 percent in 1981 to 27.5 percent in 1988.
(4) The Bush Tax Cuts of the 2000s
In 2001, Congress and the George W. Bush administration passed income-tax cuts that reduced individual tax rates by roughly 7.4 percent on the low end of the income spectrum, and by 9.3 percent on the high end. Two years later, capital gains tax rates were reduced from 20 percent and 10 percent (depending on income) to 15 percent and 5 percent, respectively. Cumulatively, these cuts led to a period of economic prosperity that lasted until the housing crisis of 2008. A few statistics are worthy of notice:
The salutary effect that lower tax rates have on an economy can be seen not only at the federal level, but also at the state level. As of May 2012, seven states had no personal income taxes (PIT) — Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. Two states taxed only income on interest and dividends — New Hampshire and Tennessee. From 2000 to 2009, the average state and local revenue growth of these nine states was 81.53%. By contrast, average revenue growth in the nine states with the highest PIT rates — Ohio, Maine, Maryland, Vermont, New Jersey, California, Oregon, Hawaii and New York — was 44.88%.
Similarly, the nine states with no PIT collectively experienced 58.54% growth in their gross state product from 2001 to 2010; the corresponding figure for the nine states with the highest PIT rates was 42.06%.
(5) The Trump Tax Cuts of 2017
On December 4, 2021, The Washington Examiner reported:
“The 2017 tax law has disproportionately benefited lower- and middle-income working families. The data show the law has also led to substantial improvements in economic mobility for middle-income and upper-middle-income households.
“A careful analysis of detailed tax data from 2017 and 2018, the first year the TCJA [Tax Cuts and Jobs Act] went into effect and the most recent year for which detailed IRS income data are available, reveals that over just one year, households with an adjusted gross income of $15,000 to $50,000 saw their total tax bills cut by an average of 16% to 26%, with most filers enjoying at least an 18% tax cut. Similarly, filers earning between $50,000 and $100,000, one of the largest groups of taxpayers, experienced a 15% to 17% tax cut, on average, from 2017 to 2018.
“Higher-income households also experienced sizable tax cuts, but not nearly as large as the tax reductions provided by the law to working and middle-class families. Those with AGIs of $500,000 to $1 million, for example, had their taxes cut by less than 9%, and filers earning $5 million to $10 million received a 3.4% cut, the lowest of any bracket provided by the IRS.
“The data also show that wealthier filers ended up providing a slightly higher proportion of total personal income tax revenue in 2018 than they did in 2017. In 2017, filers earning $500,000 or more provided 38.9% of all personal income tax revenues. In 2018, the same group provided 41.5% of revenues.”
* Adapted from “The Historical Lessons of Lower Tax Rates,” by Daniel Mitchell (August 13, 2003); “Ten Myths about the Bush Tax Cuts,” by Brian M. Riedl (January 29, 2007); and “Obama-Loving Media Spin the Economy,” by Larry Elder (May 10, 2012).
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