Top Income Tax Rates and Revenue: A Historical Perspective

By :: December 1st, 2011

By Dan Baneman and Jim Nunns

With election season heating up and 2012 just around the corner, we are hearing a lot about the pending expiration of the Bush-era tax cuts.  If the debate over the original 2010 expiration is any guide, much will center on whether the top rate should increase from 35 percent to the pre-2001 level of 39.6 percent. While these rates will be characterized as being very high, in historical terms they’re actually quite low. Between 1954 and 1963, for example, there were 24 tax brackets (compared to 6 today), and 19 of them were higher than 35 percent. The top rate? A whopping 91 percent.

Massive federal deficits and rising income inequality make it worth asking: just how important were those higher rates in raising revenue? To answer to that question, we compiled IRS data on the amount of tax generated at each statutory marginal tax rate, dating back to 1958.

This is what we found: Those high rates really did raise revenue. Although only a small fraction of tax returns were affected by very high rates, the taxes paid at those rates accounted for a substantial portion of individual income taxes paid. Between 1958 and 1986, an average of 14% of individual income tax revenues were generated at rates above 39.6 percent, and an average of 6% of revenues were generated at rates above 50 percent. At their peak in 1986, rates above 39.6 percent accounted for an impressive 23% of income tax revenue.

We did a bit of quick math to see how much revenue could be raised by boosting income tax rates. Between 1958 and 1981 (the last year with rates above 50 percent), the average effective tax rate on brackets above 35 percent was 49 percent. That is to say, the total tax paid in those brackets came out to 49 percent of the taxable income in those brackets, compared to 35 percent under the current rate structure.

In 2007, if taxable income in the 35 percent bracket had been taxed at 49 percent, federal income tax revenues would have been $78 billion higher (taking into account likely behavioral responses). That won’t solve the deficit problem, but it’s hardly chump change: an extra $78 billion would have increased 2007 income tax revenues by nearly 7%.

Restoring pre-1982 effective rates wouldn’t require implementing pre-1982 statutory rates. Raising the top statutory rates is one way to increase effective rates, but it’s not the only (or best) way. For instance, more modest rate increases could be supplemented by scaling back tax preferences that disproportionately benefit high-income taxpayers (like the mortgage interest deduction) and very high-income taxpayers (like the preferential rate on capital gains).

It’s clear that we can’t solve the deficit problem just by increasing taxes at the top.  Unless we are willing to make massive cuts in retirement and health benefits that many American families rely on, our revenue needs will be too great to avoid broader tax increases. And higher taxes should come from a reformed – fairer, simpler and more efficient – tax system.  But it may not be unreasonable to ask taxpayers at the very top of the income distribution, who have received most of the income gains over the past 30 years, to pay income taxes at levels comparable to those paid prior to the 1980s.