Saturday, November 24, 2012

The Truth about Taxes and Growth

It's Thanksgiving weekend, and some Americans have much more to be thankful for than others. This trend has been accelerating for the last thirty years, and last September, in a little-noticed study, an economist named Thomas Hungerford documented it carefully in a study for his employer, the non-partisan Congressional Research Service. You can read the study here,, and it is relatively jargon-free and scrupulously honest in its findings. The real point of the study was to test the fundamental assumption of Republican public policy: that lower taxes on high incomes will increase savings and economic growth. The study drew upon data since the end of the Second World War, and its conclusions were unequivocal.

Hugerford provided some data that I had never seen. As I have mentioned many times, the top marginal tax rate on incomes fell from 95% at the end of the Second World War to 91% shortly thereafter, where it remained until 1964. The Kennedy-Johnson tax cut, timed to favor the GI generation as it entered its peak earning years, cut it to 65%, where it remained until Ronald Reagan, who cut it to the mid-40s in 1981 and below 30% in 1986. It rose again under Bush I and Clinton, to 40%, and then fell to 35%. Capital gains taxes have fallen a similar downward path, except in the 1970s, when they reached historic highs. They held steady at 25% all through the High (1945-65), went up apparently to about 35% in the 1970s, and have fallen in stages ever since until now they are at about 18%. But Hungerford went beyond the simple top marginal rate and provided data on the effective rate paid respectively by the top .1 % (one tenth of one percent) and the top .01% of households. These figures are equally striking. The top .1%'s effective federal income taxes fell steadily from about 55% to 35% between 1945 and 1965, while the top .01% fell from 60% to 40%. Both then rose during the 1970s, to 45% for the top .01% and about 41% fort he top .1%. Then came a pretty steady fall to 25% in 1990,a figure which applied to both groups, followed by a rise under Bush II and Clinton to 31% in 1995. Then, however, two things began to happen. Even under Clinton, the effective rate paid by both groups began to fall sharply. I don't know why this was--perhaps it was at that time that investment bankers developed the "carried interest" dodge that effectively exempts them from federal income tax rates. The second thing that happened was that the top .01% began paying an even lower percentage of effective income taxes than the top .1%. For reasons which, once again, I cannot explain, their effective taxes bottomed out in 2005 and have risen slightly since. The top 1% now pay an effective rate of 26% and the top .01% pay 24%.

It's unfortunate that Hungerford did not expand his tables to include the rest of the population, and that he did not provide additional tables that would have shown the impact of payroll taxes as well. We all know thanks to Mitt Romney that 47% of households pay no federal income taxes (although they do pay payroll taxes.) We don't know what the total tax burden is, both of those 47%, and of the additional 42% who comprise most of the upper half of our society. They may have the most reason to be angry of anyone.

Hugerford then presents tables correlating the change in top rate tax brackets with changes in private savings, private investments, productivity growth, and real per capita GDP growth. I shall begin by saying that Hungerford's regression analyses--the equations that determine correlations between factors--did not find his results to be statistically significant. However, the insignificant correlations that emerged from his data were, almost without exception, opposite to what Republican ideology holds to be true. Savings and investment tend to be higher when top marginal income tax rates and capital gains rates are higher, and vice versa. Productivity growth is also positively correlated (albeit insignificantly) with higher marginal income tax rates, although negatively correlated with higher capital gains rates. Increases in real per capita income are almost totally uncorrelated with changes in tax rates.

It's hard to know exactly what to make of these figures, because I'm not sure they represent the true picture. What is indisputable, as Hungerford acknowledges, is that economic growth, productivity growth, and per capita income rose much more quickly during the High (again, 1945-65), the era of the highest effective income tax rates on the very rich, than they have since, as the Silent and Boom generations took over the world. But since 1964 top tax rates and capital gains taxes have bounced up and down a good deal, while maintaining a secular downward trend. It is those frequent changes, I suspect, that resulted in such weak correlations.

Hungerford concludes with tables correlating income inequality with changes in top tax rates and capital gains rates, and those results, of course, are striking. The top .1% (again, the top one in a thousand) of households earned about 4% of national income in 1945 and that figure dropped to about 3% in the 1970s. Then their share began to rise, reaching 12% in 2006, falling to about 8% at the depths of the recession, but now on the way back up at 9%. The question we now face in connection with the expiration of the Bush tax cuts is whether we will allow the resumption of that trend to continue. (Incidentally, for the whole of the period under consideration, the top .01% has earned about half the total income of the top .1%.)

This is good a time as any to mention a very recent story in the New York Times floating a possible "compromise" that would allow Republicans to vote for higher taxes on the wealthy without offending their enforcer, Grover Norquist. This compromise would keep the top rate where it is, at 35%, but would apply that rate to the total income of households making approximately $300,000 or more. To some one making $300,000, that would mean a substantial tax increase. To some one making $3 million, $30 million, or $300 million, it would be completely trivial, even if they were counting most of their income as wages and salary instead of carried interest. The only way we will get a genuine increase in taxes on higher brackets will be to let the Bush tax cuts expire in toto and force the Republicans to accept a compromise involving higher rates for the wealthy.

John Kenneth Galbraith frequently remarked that the world became much easier to understand if one simply kept in mind that rich people believe they should be even richer. The story of our politics over the last 30 years is terrifyingly simple. Lower taxes on the wealthy have created gigantic and growing fortunes, which enable the wealthiest to buy more and more political power, which they use to make their fortunes even larger. The is the process that the entire Republican party is now dedicated to promote. It's sad but true to note that the last time that the nation had to confront this problem, in the Progressive era, both parties included office-holders who wanted to do something about it. The situation today is very different. Hugerford's report, which received surprisingly little media attention, genuinely threatened Mitt Romney's campaign. Congressional Republicans therefore somehow forced the Congressional Research Service to withdraw it. They didn't save Romney, but we still don't know whether they will save most of the tax policy of the last thirty years and its consequences.

6 comments:

Chris said...

Sir,

I should begin by agreeing that I believe marginal tax rates are much to low. That said, I wonder whether focusing so much attention -- if not yours, then certainly mainstream progressive politics' -- on tax rates is not a bit of a red herring. I don't know what the cause of our increased economic inequality, but I am fairly sure low marginal tax rates aren't it.

Shouldn't inequality -- rather than tax rates -- be our primary concern? Yes, tax rates play a role. But it seems to me an indicator, not a cause. Forgive me for restating the obvious, but for all households, we should focus on incomes versus expenditures. Yes, wealthier people have been paying less in taxes than they would have just a few decades ago. The reduced revenue would force the government to reduce discretionary spending, specifically the non-military variety.

I am not a tax policy expert, but reduced federal non-military spending is not the genesis of Occupy, or even the degree to which we are seeing inequality like we are today. Granted, these cuts impact the social services and education spending discretionary budgets, which would hurt poorer people disproportionately. But these cuts are not foundational to a squeezed middle class, or a significantly increased level of poverty. What is the cause then?

I don't know. Probably some combination of (in no particular order) increased energy scarcity and costs, a ridiculous pattern of development ('suburbanization'), the decline of local manufacturing and even information sectors due to increased international competition, a habitual overreach of our military, an aging population, and the confusing finance with a real economy. These have in turn forced an increase in our daily 'cost of doing business', from healthcare to debt expenses, both on an individual and national scale. Equally importantly, Elizabeth Warren has beautifully pointed out the decline of real wages masked by the addition of another income to the typical family.

What I would be more interested in is, from your point of view, why taxes have occupied so much of our national bandwidth. Similarly, I believe, is how important social issues like Gay Marriage, Abortion, and even Marijuana use have become. I do not, by any means, suggest that these are unimportant. I do, however, strongly believe that these are distractions from more fundamental problems that we are itching to ignore. What is the precedent for emphasizing political points at the cost of national viability?

Thank you.

Ezra Silk said...

Hi David,

Thanks for your take on the Hungerford report, which I recently heard about. Based on your title, I was expecting a little more about growth. You did have this one line:

"It's hard to know exactly what to make of these figures, because I'm not sure they represent the true picture. What is indisputable, as Hungerford acknowledges, is that economic growth, productivity growth, and per capita income rose much more quickly during the High (again, 1945-65), the era of the highest effective income tax rates on the very rich, than they have since, as the Silent and Boom generations took over the world."

You don't make it clear, but I wonder: Are you advocating high taxes in order to not only reduce income inequality but to also increase growth?

I agree with substantially increasing taxes on the rich to reduce income inequality, full stop. But based off my increasing understanding of global warming and the associated ecological catastrophes en route, we should take a second thought on calling for a return to postwar levels of industrial growth in the developed world.

For 250 years, carbon emissions have largely tracked with industrial growth. Pro-growth environmentalists argue that we can de-couple these parallel trends, but it's basically too late. Perhaps if we had started a full transition to renewable energy sources in the 70s we would have had a chance to de-link emissions from growth. It's too late. Our atmosphere is already at 392 carbon ppm. We need to take it down to 350 ppm to even ensure survival of human civilization, according to the latest research. And we have made almost no progress on de-coupling growth from carbon emissions. Take a look at the arguments of ecological economists Kenneth Boulding, Richard Heinberg and Herman Daly -- they will explain it much better than I can.

As you will recall, Galbraith questioned the paramount position of production in The Affluent Society. The New Keynesians are making a mistake by ignoring the limits to growth critique. There needs to be an immediate alliance forged between the institutionalists and the ecological economists based off a philosophy of massive government intervention in energy policy and income redistribution. There are only a few short years left in order to avert full-on civilization collapse, and unfortunately, liberals are advocating a completely incoherent solution. They want growth and a stop to climate change. Unfortunately, we missed the boat on that one a few decades ago, as far as I can tell.

-- Your Cousin Ezra

David Kaiser said...

To Chris: Yes, although I can't prove it systematically, I believe there's a direct relationship between high marginal tax rates and economic growth. For one thing, corporate leaders are more likely to put money into investment if the government will confiscate most of larger salaries/bonuses. For another, these high rates will make the parasitical sectors of the economy much less attractive since there will be a limit to how much they can suck out of the economy.
To Ezra: I don't know how bad the climate situation is, and I don't know how much the US can do to improve it on our own. I would imagine that moving to alternative sources would cost a lot of money and create jobs. If the situation is as bad as you claim, then the alternatives seem to be either a big move to alternatives sources or some catastrophe that will drastically reduce world population! I suppose we could also try to encourage population movements to areas that use less energy, although I don't know how much that would help. Are you totally bereft of hopeful suggestions?

Bozon said...

Professor

Useful post and great commentary.

Unfortunately, merely the political structural status quo,

with the party system,

has meant industrial and commercial policy drift, forever.


Mere taxation or spending policy, per se, have both been emasculated by both fiscal, and foreign trade and investment policy.

The New Deal began the beginnings of an industrial, and national investment, policy,

that has remained totally still born since then.

All the best
GM

Ezra Silk said...

Well, you should really take a look at the latest climate research because, taken seriously, it throws into question many of our most cherished notions of industrial progress. Any attempt at placing our contemporary moment in historical context requires an understanding of the climate situation.

Take a look at this study from Jose Tapia Granados at UMich that shows the strong historic correlation between World GDP growth and carbon emissions. Put simply, emissions drop drastically during recessions in the 30s, early-to-mid 70s, early 80s, early 90s, and late 2000s.

http://sitemaker.umich.edu/tapia_granados/files/co2_emissions_and_gdp_growth_-_dec_2009_-_f2.pdf

The only points at which the correlation between industrial growth and carbon emissions weakens is during WWI and WWII, when the government rationed fuel and there were massive declines in car sales.

You ask whether I am bereft of hopeful solutions. I think it's important to understand the problems before we start administering solutions. Unfortunately, the left-wing of the Democratic party, the only hope for America as I see it, doesn't even understand the crisis at hand.

What we clearly need is massive government intervention on behalf of a Green New Deal that would provide direct public employment for building new alternative energy and public transportation systems across the country. We will probably need to ration fuel, along the lines of WWII.

The ecological economists call for the transition to steady-state economy. This means no growth, i.e. stagnation. Forever. This would require a major expansion of the safety net, in the form of, most likely, a guaranteed government income for all.

Now, whether such an economy is possible is another question. But our growth model is driving us straight off a cliff. We need to come up with something else. A humane type of environmental austerity seems to be the only solution. Unfortunately, we have barely even started to consider the implications of this.

Margaret Bado said...

There is a HUGE wealth gap from the top 2% to the 3% and this information is misinformed and ignorant. The entire working class of America receives around 3% of the wealth, while ONE RICH family receives MORE THAN 30% OF AMERICAS WEALTH! Corporations like GE DIDN'T PAY ANY TAXES ON OVER $100 BILLION! That's more tax than the working class creates. Centralized banking is the problem, which is why our forefathers who created this country had WAR on centralized banking. This country went to shit 2013 tax brackets.