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.

 

20Comments

  1. Vivian Darkbloom  ::  2:25 pm on December 1st, 2011:

    I’m having a hard time understanding what the revelation is here. Raising statutory marginal rates will have the effect of raising effective rates which will have the effect of raising revenue?

    If you want to raise additional revenue by increasing the percentage of revenue generated from income subject to tax at the highest marginal rate, you do not need to raise the marginal stautory rate. All you need to do is lower the income threshold so that more income is subject to the existing marginal rate of 35 percent. And then, presto, you can claim that those paying at the highest marginal rate are contributing a greater percentage of the overall tax take. Or, if you have a flat tax, 100 percent of the revenue is raised by those paying at the margin!

    Part of the problem, which the authors belatedly admit, is that they move rather too seamlessly between statutory marginal rates and effective tax rates and seem to confuse the two and thus really fail to answer their own question: “how much revenue was raised by those high rates” (rather than, say lack of tax expenditures)?

    For example:

    “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.”

    So, how much of this “average effective rate of 49 percent” was due to the higher statutory rate? And, the statement that the total tax paid in those brackets came out to 49 percent of the *taxable income* does not sound to me as though it is an expression of the *effective* tax rate any more than 35 percent could be the *effective tax rate* under the “current rate structure” as per the TPC’s own research here:

    http://www.taxpolicycenter.org/taxfacts/displayafact.cfm?Docid=366&Topic2id=48

    I hate to discourage these two authors from trying; however, based on the above, I can’t say I’ve got much confidence in how the the $78 billion estimate was derived. But, let me try. It seems as though they are saying: if we go back and 1) change the existing marginal rate from 35 percent to 49 percent; and 2) eliminate *all* tax expenditures such that marginal rate is also the effective rate, we could have raised $78 billion more in 2007.

  2. AMTbuff  ::  5:12 pm on December 1st, 2011:

    When you consider that Medicare tax, state income tax and sales tax rates are much higher today than pre-1982, raising federal tax rates back to pre-1982 levels would be a substantial increase over historical tax rates. On top of that are sneaky phase-outs and the new Obamacare taxes which begin in 2013. The increase in these other taxes since 1982 probably approaches 10% of income.

    When my combined marginal tax rate (the actual marginal rate, computed by adding $1000 to income using tax software) exceeds 70%, I stop earning money and start taking unpaid time off.

    As a side note, it’s fascinating that none of the press articles or arguments for restricting the mortgage interest deduction mention either the possibility that housing prices may decline significantly or the likely financial consequences of another housing price dip. The time to slam the housing market is when it’s flying high, not when it has taken its worst beating since the 1930s.

    Bowles-Simpson would have cut the value of the mortgage deduction approximately in half. The 2% of AGI cap proposal being floated would effectively eliminate the deduction except in very low-tax states. Years later, Congress would claim that the effect on housing prices was an unintended consequence, as if nobody had predicted it.

  3. George  ::  6:16 pm on December 1st, 2011:

    I can’t believe there used to be a 91% tax rate. Whose great idea was that? I thought this was America. Government is supposed to stay out of our lives as much as possible. Why bother earning that extra dollar if Uncle Sam is going to take $.91 of it.

  4. Michael Bindner  ::  8:13 pm on December 1st, 2011:

    The chief aim of a 91% rate is not to raise revenue but to prevent the payment of income and encourage higher salaries for the workforce, since most businesses would rather pay their workers than the government. Not taking this income in taxes encourages management to decrease worker wages and keep the proceeds. Of course, making such a point is considered class warfare – especially by people who are being funded by people formerly paying a 91% tax rate.

  5. Michael Bindner  ::  8:14 pm on December 1st, 2011:

    Ike

  6. Michael Bindner  ::  8:20 pm on December 1st, 2011:

    After the mortgage has been paid for a while, the value of the MID is minimal as interest is much lower – especially for people who have low interest mortgages or who have considerable higher incomes because they are older but the same house that they had when younger with a lower income.

  7. Bob Murphy  ::  11:53 pm on December 1st, 2011:

    Can the authors explain a bit more about how they took into account the “likely behavioral responses”? That’s the whole issue, isn’t it? A supply-sider will say the massive explosion in income at the top percentiles since the 1980s was due precisely to the lowered marginal rates. I don’t have the numbers handy, but I know that tax receipts from the top 1% as a share of GDP rose from 1978 to 2007. (I just saw a paper on this, which is why I’m picking those dates.) The supply-sider who wielded those figures was arguing that that totally vindicated the tax rate reductions.

    It seems the authors of this post are assuming that the growth in top income earnings would have been largely the same with tax rates of 70 vs. 39 percent or whatever?

  8. SteveinCH  ::  3:18 pm on December 2nd, 2011:

    A while meaning 15 years or so? After 15 years, a mortgage payment is still about 65 percent interest.

    Nice try though.

  9. Ralph H  ::  11:37 am on December 3rd, 2011:

    The graph while interesting, is useless as any predicter. For example the 82-02 period clearly shows how inflation (or growth) increases tax revenues but there is minimal % change if you combine the top rates. A more interesting and useful plot would be tax revenues vs rates.

  10. Brian Dell  ::  11:56 am on December 3rd, 2011:

    No, it wasn’t Ike, it was FDR, who introduced a 94% rate on income over $200K.

  11. Around The Dial – December 5, 2011 | South By North Strategies, Ltd.  ::  3:04 pm on December 5th, 2011:

    […] TaxVox tracks changes in the top marginal income tax rate. […]

  12. Finley  ::  3:39 pm on December 5th, 2011:

    It is amazing to me how many people don’t realize this. The top marginal tax rate was above 50% between the years 1932 to 1987. The republican idea that a high marginal rate is a growth killer is not at all substantiated by actual history. there were certainly periods of very strong growth with top marginal income tax rates that were, at times, literally twice as high as today’s 35%.

  13. Finley  ::  3:57 pm on December 5th, 2011:

    depends on the interest rate. As the interest rate decreases, the percent of a payment that is interest at year 15 would be less. For instance: if your interest rate is zero percent, the year 15 payment going towards paying interest would also be zero percent.

    If you got a 30 year fixed at 5% today about half of your year 15 payment goes towards interest, and half to principal.

  14. Finley  ::  4:07 pm on December 5th, 2011:

    It completely depends what income bracket you are in. If you were in the top bracket in 1980 you were paying a rate of 70%. On top of this you were paying social security, medicare, property, sales tax. State income taxes were generally lower. But overall its hard to imagine you would be paying more today than you you would have been then, with a 35% top bracket now (half as much as it was). If you aren’t in the top bracket then i find it pretty hard to believe your actual top marginal rate is 70%. Even if you are in the top bracket and pay this rate then you need a new tax adviser.

    also FYI, total tax revenue as a percentage of GDP is 15% right now. This is the lowest it has been since 1950, when tax cuts combined with a recession had caused a big drop in tax revenues.

  15. William  ::  5:56 pm on December 5th, 2011:

    It’s amazing to me how many people don’t realize that JFK was the first to cut the FDR 91% tax rate. The GOP idea that low tax rates bring about growth in income for all levels is unquestionably substantiaed by history. Coolidge and Mellon kept rates low in the 1920’s, a period of unprecedented growth. FDR needed money for his kenyesian programs that didn’t work. He raised taxes several times to get them to the 91% rate where they remained until JFK cut them amidst the early 1960’s recession. During the 1970’s, the American economy was bogged down by inflation and unemployment. Reagan’s tax cuts of the 80’s brought about 25 years of growth. What I don’t understand is why are we even arguing about this anymore?

  16. McLaughlin  ::  7:08 am on December 6th, 2011:

    Restoring pre-1982 effective rates.. could be supplemented by scaling back tax preferences …like the preferential rate on capital gains).

    So hike income taxes and eliminate Pres Clinton’s sensible reduction of taxes on saving, too? It was the capital gains tax cut (Taxpayer Relief Act) that delivered the budget surplus, for goodness sake.

  17. What if Federal Income Tax Rates Were Higher at High Income Levels?  ::  9:56 am on December 6th, 2011:

    […] a joint effort of the Urban Institute and the Brookings Institution dispenses with the question of how much how much tax revenue is generated at higher levels of tax rates. It also undermines some of the supply-side scripture that high marginal tax rates are […]

  18. fort worth cpa  ::  9:23 pm on December 14th, 2011:

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  19. Alan Reynolds  ::  1:56 pm on December 19th, 2011:

    To show that some taxes were actually paid at rates of 50-91% does not demonstrate that more taxes would not have been paid if marginal tax rates had been more reasonable.

    The elasticity of taxable income among the top 0.5% – 1% is estimated to range from 0.6 for gross income (Emmanuel Saez) to more than 1.0 for taxable income (Treasury Office of Tax Analysis).

    If high tax rates on high incomes were effective, why did individual tax reciepts rise as share of GDP after marginal tax rates were slashed by 23% in 1964 and rise again after marginal tax rates were slashed by another 23% in 1983?

    Individual income tax rates of 20-91% from 1951-63 raised 7.7% of GDP in receipts. Tax rates of 14-70% from 1964 to 1981 raised 8% of GDP. Tax rates of 11-50% from 1983 to 1986 raised 8.3% of GDP. And tax rates of 15-39.6% from 1993 to 1996 raised 8% of GDP.

    The government can’t afford to bring back the high tax rates of the 1970s, much less those of the Eisenhower era, even aside from the obvious damage to the economy.

    http://www.cato.org/pub_display.php?pub_id=13204

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