By Mehrun Etebari
July 17, 2003
We've all heard the claims that cutting tax rates for the richest Americans will improve the standard of living for the working class. Supposedly, top-bracket tax breaks will result in more jobs being created, higher wages for the average worker, and an overall upturn in our economy. It's at the heart of the infamous trickle-down theory.
The past 40 years have seen a gradual decrease in the top bracket's income tax rate, from 91% in 1963 to 35% in 2003. It went as low as 28% in 1988 and 1989 due to legislation passed under Reagan, the trickle-down theory's most famous adherent. The Clinton years saw the top bracket hold steady at a higher rate of 39.6%, but under the younger Bush's tax-cut policies, the rich are once again paying less. The drastic change in tax policy that has taken place since the early 1960s gives us a great opportunity to study and evaluate the claims that lower taxes for the rich translate to more wealth for the average American.
We can compare changes in the top tax rate with the real GDP growth rate (a measure of the growth of the entire U.S. economy), and three measures of how life is for the average working American: annual median income growth, annual average hourly wage growth, and job creation. If cuts for the rich were really the magic elixir for the economy and the middle class that the Republican consensus claims it is, we would see an increase in the four indicators whenever the tax rate dropped. However, this is not the case. Such a trend occurs sometimes, but the opposite happens at other times!
Let's look one by one at comparisons of key economic indicators to the top tax rate.
1. Cutting the top tax rate does not lead to economic growth.
This graph shows the fluctuations of the real GDP growth rate over the period, indicating the performance of the U.S. economy as a whole. It is true that growth increased drastically after the 1982 tax cut, reaching as high as 7.3% in 1984. However, as the Reagan-Bush, Sr. administrations went on and taxes for the rich were slashed even further, growth fell to negative levels during 1991, at the heart of the last recession. And, two of the three years with the highest growth were during the 1950s, when the top tax rate was 91%. Overall, there seems to be no close relationship between the top tax rate and the GDP growth rate, and statistical analysis backs this up: the correlation coefficient between the two variables is 0.03, meaning that there is essentially no connection. (If tax cuts were strongly related to GDP growth, we would see a coefficient close to -1.) So much for upper-class tax cuts boosting the economy; now it's on to median income growth.
2. Cutting the top tax rate does not lead to income growth.
Again, we see inconclusive evidence for the power of tax cuts. We do see small peaks in median income growth, a good measure of how the average American household is doing, after top-bracket tax cuts in the mid-1960s and early 1980s, but we also actually see income decreases after the tax cuts of the late 1980s, and strong growth after the tax increase of 1993. It is true that in the year with the worst median income decrease (3.3% in 1974), the top tax rate was 70%. However, it was also 70% in the year with the highest median income growth (4.7% in 1972)! Once again, the lack of connection between the two measures is backed up by a correlation coefficient near zero: 0.06, to be exact. And yes, yet again, the coefficient is positive, indicating that income has gone up slightly (though negligibly) more in years with higher taxes. Two strikes. How about hourly wages?
3. Cutting the top tax rate does not lead to wage growth.
Not surprisingly, we have mixed results yet again! Growth in average hourly wages did increase during the 1980s following the first Reagan tax cuts, albeit two years after the cuts took effect. But, just like GDP growth and median income growth, hourly wages decreased following the late 1980s tax cuts, and spiked upwards after the 1993 tax increase.
Furthermore, wages grew at a level of at least 1%, and usually much more, all throughout the period when the top income tax rate was 91%. In fact, it isn't until 1972 that we see a wage growth rate of less than 1%. However, if we look at the 19 years of the study period when the top tax rate was 50% or less, we see that 8 of the years saw an increase in wages of less than 1%. Thus, it seems that hourly wages grew more when taxes were higher - indeed, the correlation coefficient is 0.34, indicating a mild positive relationship between higher taxes for the rich and higher hourly wages. This finding flies in the face of the conservative theory. As if that's not enough, now let's see about what President Bush claimed would be the biggest result of tax cuts - job creation.
4. Cutting the top tax rate does not lead to job creation.
Here, we see the change in the unemployment rate laid against the top tax rate from 1954 to 2002. Thus, negative values signify a decrease in unemployment -- in essence, job creation. Once again, while the top tax rate trends downward over the period, the annual change in unemployment doesn't seem to trend at all! Although the largest increase (2.9%) did occur in 1975, when the top marginal tax rate was 70%, three of the four largest decreases in unemployment occurred in years when the top rate was 91%. The mixed results do not bode well for those who see tax cuts for the richest as a sparkplug to incite job growth. The correlation coefficient between the variables here is 0.11 -- meaning that there have been slightly more jobs created in years with lower top tax rates, but this pattern is negligible -- nowhere near strong enough to signify a relationship.
So, can you tell what our conclusion is yet?
Overall, data from the past 50 years strongly refutes any arguments that cutting taxes for the richest Americans will improve the economic standing of the lower and middle classes or the nation as a whole. To be sure, the economic indicators examined in this report are dependent on a variety of factors, not just tax policy. However, what this study does show is that any attempt to stimulate economic growth by cutting taxes for the rich will do nothing -- it hasn't worked over the past 50 years, so why would it work in the future? To put it simply and bluntly, Bush's top-bracket tax cut is an ineffective attempt at stimulus that will not cause any growth -- unless, of course, if you're talking about the size of the deficit.
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“Professors James Gwartney and Richard Stroup (1982) have examined the changes in the distribution of the tax burden following the Mellon tax cut of the 1920s and the Kennedy tax cuts of the 1960s. In the case of the Mellon tax cuts, named after Treasury Secretary Andrew Mellon, marginal tax rates that reached 73 percent in 1921 were reduced to a top rate of 25 percent by 1926. The effect on the economy was positive: “The economy’s performance during the 1921-26 period was quite impressive. Price stability accompanied a rapid growth in real output.”
Gwartney and Stroup found the shift in the tax burden equally impressive. By 1926 personal income tax revenues from returns reporting $10,000 or less dropped to 4.6 percent of total collections, compared to 22.5 percent in 1921. In contrast total income tax revenues from returns by people with incomes of $100,000 or more rose to 50.9 percent in 1926 from 28.1 percent to 1921. They conclude that “as a result of the strong response of high-income taxpayers, the tax cuts of the 1920s actually shifted the tax burden to the higher income brackets even though the rate reductions were greatest in this area.”
Their analysis of the Kennedy tax rate reductions (which cut the top rate from 91 to 70 percent) yields similar results. In 1965, after the tax rate reductions, collections from the highest 5 percent of income earners rose to 38.5 percent of the total from 35.6 percent in 1963. In contrast, the proportion of income tax revenues from the bottom 50 percent of tax returns fell from 10.9 percent in 1963 to 9.5 percent in 1965.
In testimony before the Joint Economic Committee of Congress in 1984, Gwartney noted that the Economic Recovery Tax Act of 1981 (ERTA) yielded similar results. The reduction of the top marginal tax rate from 70 to 50 percent cut the tax rates paid by high-income earners by as much as 28.6 percent, but tax revenues collected from the rich increased. Revenues from the top 1.36 percent of taxpayers, the group that most benefited from the rate reductions, rose from $58.0 billion in 1981 to $60.5 billion in 1982. The proportion of the total income tax collected from the top 1.36 percent of taxpayers rose to 21.8 percent in 1982 from20.4 percent in 1981.
The tax liability of low-income taxpayers fell both in absolute terms and as a percentage of the total. Taxes paid by the bottom 50 percent of income earners fell from $21.7 billion in 1981 to $19.5 billion 1982, and the share shrank from 7.6 percent in 1981 to 7.0 percent in 1982. Gwart ney concludes that:
“far from creating a windfall gain for the rich, as some have charged, ERTA actually shifted the burden of the income tax toward taxpayers in upper brackets, including those who received the largest rate reductions as the result of the 50 percent rate ceiling.”
This seems to be a general conclusion supported by the empirical evidence from marginal income tax rate reductions in the United States. A Joint Economic Committee staff study, “The Mellon and Kennedy Tax Cuts: A Review and Analysis” (1982), found that tax cuts in the 1920s and 1960s led to a rise in tax revenue, particularly from the rich. During the decade of the 1920s despite, or because of, the tax cuts, Treasury Secretary Mellon was able to pay off 36% of the national debt."
For more, read Dr. Paul Craig Roberts’ full 55 pg. article on Supply Side Economic Theory: https://www.paulcraigroberts.org/2017/07/17/supply-side-economics-theory-results/
Trickle-down economics is a colloquial term for supply-side economic policies.
“No such theory has been found in even the most voluminous and learned histories of economic theories, including J.A. Schumpeter’s monumental 1,260-page History of Economic Analysis. Yet this non-existent theory* has become the object of denunciations from the pages of the New York Times and the Washington Post to the political arena. It has been attacked by Professor Paul Krugman of Princeton and Professor Peter Corning of Stanford, among others, and similar attacks have been repeated as far away as India. It is a classic example of arguing against a caricature instead of confronting the argument actually made.”*
Over the next few years and a series of tax cuts, the top marginal tax rate cut to 24%, the overall tax revenue for that year was over $1 billion, and those making above $100,000 payed 65% of that total. This significantly reduce the tax burden on low income earners. For example those making below $5,000 in 1920 paid 15.4% of the total revenue and in 1929 the paid 0.4%. If you want more revenue from the rich, don’t incentives them to store their money in places you can’t reach it by raise taxes. Lower them and they will pay more.
sources: https://www.jstor.org/stable/24441285?seq=1#metadata_info_tab_contents, and https://www.hoover.org/sites/default/files/uploads/documents/Sowell_TrickleDown_FINAL.pdf
To describe this experiment to see if it works we give money to those who actually need the money to buy things they need and/or want but don’t have enough money to buy.
What do we think will happen when these people have more money? I think the money has a far higher probability of being spent because it’s now in the hands of people who need and want to spend it. They will buy product which then helps all the companies in the supply chain and then the manufacturers will perhaps have to make more product and maybe hire more workers. If they have to hire more workers there will then be more people with money to spend.
“It just works!” they say. Just listen to this (grossly oversimplified) explanation. But what about the data? What about REALITY? If you don’t understand what a “correlation coefficient” measures, of course the graphs will make no sense to you. It means that all these things that are supposed to be improved by a top tax rate cut – were not. Period. Science seems to be a sore point for conservatives, until they get on the next airplane, and they are glad the slide rule pocket protector types have figured it all out. The theory does not pan out in fact. The grossly oversimplified explanation of how logical it is – amounts to nothing in the real world that can be measured or observed."
Arrogant hypocrite, cutting taxes for “the rich” (anyone that has additional funds to invest thanks to the tax relief) does tend to lead, in the current “global” environment, to having investors send some of their money around the world where they get the best returns. Rather than wondering how to make our nation more competitive in lagging sectors, you instead offer sophisty about your “graphs” to justify economic fascism as a matter of “common sense” or empiracism when you’re not telling the whole story. What about Social Justice? Why won’t you allow other economies to catch up? You prefer to tax “the rich” so that you can engage in a little Social Justice and or Keneysian demogoguery.
Investment flows out when we Americans can not compete economically in some project or enterprise. Not because the government needs to nationalize everything. Because that is where your “scientific” models take us.
“Science seems to be a sore point for conservatives, until they get on the next airplane, and they are glad the slide rule pocket protector types have figured it all out.”
Get a life.
That’s true. They seek maximum return on their capital. So where do they put it? You’re implying that this “extra money” is “lost” because it’s not taken by the government. This is false. This is a classic example from “broken window” fallacies.
“If you have a demand for lets say 100 of something and say realistically to make them in time 1 person can make 5, a business is not going to hire more than 20 workers just because it has more money left over after overhead costs and taxes. "
This is a straw man argument. The question is whether (assuming we set aside moral questions regarding who has “rights” to take these profits) the private sector or the government will make best use of those “excess” funds for the sake of maximum GDP, again, assuming that is your goal.
“Demand creates jobs, new technology’s and infrastructure.”
Real demand creates useful jobs. “Busywork” wastes resources. Demand does not create infrastructure. And not all “infrastructure” investments lead to real increases in “wealth.” Dig a ditch and then fill it just keeps people busy and maybe improves their health but it doesn’t improve “the economy.” Unless you use mendaciously framed statistics to measure “currency” without counting all of the costs.
“Here’s where trickle down hurts the economy. The average earner of 250k or greater per year spends just 15-35% of their yearly wages. The average middle and lower class family spends 100-110% of their annual income. When money is mobile the economy is good and it is more mobile in the hands of the middle and lower class than the wealthy.”
That makes no sense. If A earns X wages in a free market, your interventions might help you model something better. That’s financial modeling that rarely stands up to real world scrutiny. But by taxing A and creating busywork for B or C you are only playing nutshell games with money. These are just sophomoric models used to hide income redistribution schemes. You have to show how redistribution is itself “valuable” to GDP. One can show models that support “safety net” policies can do that, but not progressive taxes that central planners use to imagine that they can lead consumerism and maximize economic output.
You’re such demagogic liars.
That’s why the world’s in the state it’s in, corporate brainwashing for decades. The golden period of capitalism was in the deacdes after WW2 when governments around the world spent on infrastructure to rebuild and created social safety nets and health care systems to support ordinary people who had lost those who had sacrificed their lives for their country. That resulted in a period of extraordinary growth through Keynesian economics and high taxation on companies and the rich. The more those taxes have been reduced the more the state has to be reduced and the more money is concentrated into fewer hands. It’s not complicated at all.
Wealth redistribution is an essential check on capitalism, the market doesn’t adjust itself, it needs constant intervention. To say otherwise is just propaganda. Companies need constant welfare from the state or else why do you think they spend so much on spreading their message, buying politicians, etc. Because it’s not a natural state of affairs, it needs constant interference and people’s minds to sustain it.
So maybe some redistribution is a good thing? if it’s being taken from the wealthy then who gets it? the small invester