American Taxation

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IT HAS LONG BEEN known that high marginal rates simply do not achieve their purpose in the real world.

An especially popular way to deal with high marginal rates at the time was with allowable deductions, for a deduction from taxable income is obviously worth more the higher the marginal rate. In the 1950s, when the top rate was 91 percent, what was nominally a 5 percent interest rate was, thanks to the deductibility of interest payments, a .45 percent interest rate for the rich man, while Uncle Sam picked up the other 4.55 percent.

AN INCOME TAX SYSTEM featuring high marginal rates and generous deductions is, not to put too fine a point on it, a welfare program for the rich, and a very generous one at that. It is also economic lunacy in a capitalist economy, for it channels investment into swimming pools, yachts, and Rembrandts instead of income-producing assets.

 

John F. Kennedy understood this, and because he was a Democrat, he was able to do something about it. In 1964 the top marginal rate was lowered from 91 percent to 70, and many aspects of the tax law designed to offset those high rates were eliminated. Just as had happened in the 1920s, tax revenues before long increased, and the rich began to pay a larger percentage of total taxes collected. In the first year of the new rates, those in the highest bracket declared more taxable income and paid more taxes than they would have had to do under the old law.

In the 1970s another disadvantage to trying to achieve progressivity with high marginal rates became manifest. The wracking inflation of that decade pushed people into higher and higher brackets, forcing those living principally on wages (who have few tax shelters) to pay high and higher taxes while not receiving, in real terms, a higher income.

But by this time the federal budget’s spending machine was gaining momentum, and many politicians were losing touch with the real world beyond Washington. In the late seventies Rep. Jack Kemp and Sen. William Roth, both Republicans, proposed slashing marginal tax rates for everyone while, once again, plugging loopholes. Democrats derided the proposal. When Ronald Reagan embraced it, President Jimmy Carter started calling it the “Reagan-Kemp-Roth” tax proposal, hoping to tar his opponent with the brush of “tax cuts for the rich.” Jimmy Carter became the first elected President to be defeated for re-election since Herbert Hoover.

Reagan cut taxes the first year he was in office, lowering rates to a high of 50 percent and again slashing deductions. As before, the government’s total tax receipts increased, and the percentage paid by those in the higher income range sharply increased. In 1986, working with the Democratic representative Dan Rostenkowski, chairman of the tax-writing House Ways and Means Committee, Reagan slashed rates again, this time to only two brackets, 15 and 28 percent, while eliminating most remaining open-ended deductions. It was the greatest reform of the federal tax system since the introduction of the income tax itself and, as before, produced higher revenues and higher tax payments by the rich. In 1981 those with the top one percent of incomes paid 17.9 percent of personal income taxes. In 1990 they paid 25.6 percent, an increase in their portion of 43 percent. Meanwhile federal tax revenues rose by more than 24 percent in real terms during the 1980s.

But the Washington spending machine was now out of control. With massive new spending programs out of the question because of the deficit, tax credits for worthwhile causes multiplied. This kept the spending out of the federal budget by hiding it in tax law. Tax credits, by reducing taxes owed rather than taxable income, at least were of some value to individuals. But it is still hard to justify a $480 income tax credit for child care for someone with a milliondollar income. And some tax credits for corporations, such as the one for ethanol additives to fuel, are cash cows, as that one is for Archer-Daniels-Midland, the giant grain company that lobbied furiously for it.

Amid low inflation in the 1980s, the deficit exploded, and the new President, George Bush, caved in to the Democratic majorities in Congress and broke his pledge of “no new taxes.” He, too, was decisively defeated for re-election. In 1993 his successor again raised marginal rates and created five brackets where only two had existed seven years earlier. But he had to do it without any Republican help in Congress, and his bill carried in the House by a single vote only when several Democratic legislators were promised virtually anything to go along. The following year many of those Democrats were defeated for re-election and the Clinton Presidency was nearly crippled as a result of the Republican landslide that wiped out the House’s Democratic majority for the first time in forty years.