Courtesy of Liberal America, with over 5,900 likes and 9,700 shares. This meme has been spread extensively in various forms, including a Paul Krugman New York Times column heralding the 1950s and the high tax rates. On the surface, it seems like a strong argument for a steep progressive tax rate. After all, we had a 91-92% top tax bracket in the 1950s, while having a fairly strong economy and middle class. Who but the greedy fat cats could argue against similar tax rates today? However, when the context of the 92% figure is examined more closely, it turns out to be a quite weak, if not dishonest argument.
Adjusting For Inflation
Using an inflation calculator, a $400,000 income in 1955 would be the equivalent of over $3.5 million today. For context, only 1% of income earners in the US have a taxable income over $428,000, which means a similar tax rate today would only apply to a tiny fraction of the 1%. It would also only apply to income over that amount.
Did Anyone Pay It?
This seems like an obvious, simple question, but one that those citing this statistic surprisingly like to ignore. After all, what does it matter what the official rate is, if no one paid it? In 1958, out of 45.6 million tax filers, only about 10,000 reported incomes subject to the 81% rate or above. This means only .02% of filers had any income taxed at the 81% rate, let alone the 91% rate! (note: the 81% bracket was from $140,000-$400,000)
Reliable data concerning what top income earners actually paid in taxes during the 50’s is hard to come by, but ironically, Thomas Piketty (who is best known as the French economist promoting progressive tax rates) compiled data estimating tax rates in 1960, when the top rate was still 91%. According to his data, shown in the chart below, the top .01% of income earners paid an effective 31% income tax rate in 1960, compared with a rate of 25% in 2004. While slightly higher, it’s fairly similar considering the huge variation in marginal rates (91% vs 36%). Piketty does claim the rich were more affected by corporate tax rates in the 50’s, as shown on the chart, but the Manhattan Institute has a good rebuttal to that finding in this paper.
Another study from the Congressional Research Service, estimated the effective tax rate on the top .01% of earners during the 50’s to be 45%. In either case, it seems the average taxes paid by the rich were 50% or less.
If the rich in the 50’s were truly being soaked relative to the middle class, we would expect them to be shouldering a much higher percentage of the tax burden. This doesn’t appear to be the case. In 1958, the top 3% of taxpayers earned 14.7% of all adjusted gross income and paid 29.2% of all federal income taxes. By 2010, the top 3% earned 27.2% of adjusted gross income and their share of all federal taxes rose proportionally, to 51%. Contrary to the view that the rich paid a larger (or “fairer”) share in the 50’s, it appears to have remained roughly the same.
Furthermore, the high marginal rates on the rich didn’t seem to affect the amount the government collected in either income taxes or total taxes. As seen below, this amount has stayed relatively fixed for the decades after World War II, despite the wide variation in official rates. Saying these rates “helped us go to the moon” is no truer than our current rates helping us go to Mars. Source
How could the rates be so high in the 50’s, yet the rich not pay them?
Deductions and Loopholes!
The reality is that with a good accountant, the wealthy in the 50’s could dramatically lower their taxes. Wealthy people generally either own or run businesses, and the bulk of their wealth comes from investments and equity. This gives them more flexibility to find lower rates in the tax code. If the income tax is raised higher than corporate or capital gains taxes, a business owner could give themselves a smaller paycheck while taking the bulk of their money in stock (like Warren Buffet getting a payroll salary of only $100,000). Since the capital gains and corporate rates were much lower than the high income tax rates in the 50’s, it’s obvious that most would opt to not get paid in normal wages.
While we still hear about deductions and loopholes today, they are not nearly what they once were. In an age with rates above 70%, it’s easy to imagine the motivation to do everything possible to avoid taxes. It was an age where deducting luxuries like personal chefs, yachts and country club memberships were still a possibility. It was also an age where reporting losses could be deducted without limit, bringing us to the next doozy.
The Real Estate Deduction
This was perhaps the most common technique for tax shelters. Before 1986, many wealthy people would make real estate investments, even if it didn’t provide a profit. This is because the IRS considered real estate to be a depreciating asset. Despite the fact it usually increases, they amazingly considered every property to depreciate at a rate making it worth 0 in 27.5 years! This meant that investors in real estate could write off losses every year, whether or not they had a loss, offsetting their taxable income.
Here’s an example of how this worked: if a wealthy lawyer or doctor earned $100,000, but they owned a rental property worth $275,000, they could deduct $10,000/year in losses, even if they broke even on it. Now their taxable income would only be $90,000. If the lawyer owned 10 such properties, their taxable income would be 0 according to the IRS! Not surprisingly, these investments were commonplace, often with investors pooling together.
When the income tax rates were cut under Reagan, this loophole was mostly closed in exchange under the Tax Reform Act of 1986. Only the mortgage interest deduction remained for real estate for most taxpayers. Under the current code, if a lawyer earns $500,000, they can only deduct $3,000 in all losses, no matter how real or large.
Since it’s clear the rich didn’t pay the high income tax rates of the 50’s, there is no sound logic correlating those rates to the economy, or of an increased standard of living for the middle class. Doing so would open up many counterarguments equally plausible, if not more so. Here are just a few examples:
- The post-Civil War period, from the 1870s through World War I, saw the strongest economic growth and standard of living increases in US history for all classes. Yet, for most of this period there was no income tax on anyone. Using this meme’s logic, we should correlate prosperity with no income tax.
- There were few public welfare programs in the 50’s. No Medicare, Medicaid, etc. Entitlement programs spent between 3-5% of GDP in the 50’s, vs about 17% now. According to this meme’s logic, we should correlate lack of welfare with the 1950’s prosperity.
- Regulations were far fewer in the 50’s. No OSHA, EPA or discrimination laws. Entire federal departments like Transportation, EPA and Education didn’t exist. According to this meme’s logic, less regulations should be responsible for the 1950’s prosperity.
It’s safe to assume the perpetrators of this meme would likely not consistently apply their logic to these areas, making it dishonest.
Correlating the high marginal tax rates of the 50’s with economic prosperity is misleading. Those rates were never paid, and there are countless other factors affecting the economy making it ridiculous to cherry pick one item. So many things factored into the 1950s economy, including a world devastated by World War II, with the United States having the best and most unscathed economy to manufacture the world’s goods. Today’s economy is much more competitive globally. Regulations are also much stricter, and the tax code doesn’t allow for near the amount of deductions and shelters it once did.
Raising marginal rates anything close to what they were in the 50’s with our current code would mean the US would have its first experience with truly high income taxes. Unless one thinks the rich, who have the greatest means to flee and avoid taxes, will gladly work for 10, 20 or 30 cents on the dollar, the expected change in their economic behavior will be predictable, and not desirable.