Between 1945 to 1963 the highest marginal tax rate in the United States was 91 percent, for incomes above $400,000, which in current dollars would be between $3 million to $6 million, depending upon the start date.
These high rates might be the reason why CEOs were not paid ungodly sums as compensation because amounts above $140,000 were taxed at 81 percent, and above $400,000 at 91 percent. Why get paid a lot if most of the money went to Uncle Sam? The highest rate was reduced to 77 percent in 1964 and to 70 percent in 1965.
Enter Ronald Reagan as president who reduced the highest marginal rate to 50 percent in 1982, to 38.5 percent in 1987 and 28 percent in 1988. He was a big proponent of supply side economics, which believes that tax cuts for the wealthy lead to higher investments, producing economic benefits that trickle down to the entire economy. A rising tide would lead to widespread prosperity. So did it?
During the 1980s, some years experienced real GDP growth that exceeded 3 percent. In 1984 the growth rate was an outstanding 7.2 percent. Reagan was a hero and is still considered one today. Tax cuts — along with deregulation — were the hallmarks of Presidents George Bush and Donald Trump’s economic policies.
But a closer look at 1980s compared to 1970s data, parsed by income groups, paints a very different and stark picture. Look at the graph that compares income growth between the 1970s and 1980s for different income groups. During the 1970s, when taxes were higher — colored in blue — income growth was about even across most income groups, but slightly lower for the middle 40 percent which makes up most of the middle class. Shifting to the 1980s — colored in orange — shows a completely different picture.
The top 1 percent experienced a 60 percent growth in real income, about 38 percent growth for the top five percent, 30 percent for top 10 percent, 12 percent for the middle 40 percent and a negative one percent for the bottom 50 percent. So, it is quite clear that most of the economic growth was harvested by the top 50 percent of income earners. The bottom 50 percent saw no improvement. So, there was zero evidence that a rising tide lifts all incomes. And a reminder that globalization could not be blamed. China was not in the picture yet.
The next graph shows pre-tax income growth for the five income quintiles — top 20 percent, next 20 percent and so on — and also a line that charts income growth for the top five percent between 1967 and 2019. As you can see pre-tax income growth began to widen sharply beginning in the 1980s, and the globalization trend that began in 2000 exacerbated it. No evidence again that tax cuts helped the bottom income earners.
But after taxes paid by high-income earners, and the benefits that are paid to lower income people — called transfer payments — are accounted for, income inequality declines significantly. Suffice it to say that the Gini Index, which is a measure of income inequality — a lower number implies less inequality — declines significantly after accounting for taxes and transfer payments.
According to an article by conservatives Phil Gramm and John Early from the Wall Street Journal that was recently reprinted in the Tampa Bay Times, taxes and transfer payments reduced the Gini Index from a pre-tax 0.48 to 0.34 on an after-tax and transfer payments basis.
Tacitly, they are admitting that tax cuts are not the magic and universal elixir that they were thought to be. Government intervention is needed to complement an efficient and dynamic free-market economy, if you do not want a vast number of people mired in poverty.
Murad Antia teaches finance at the Muma College of Business, University of South Florida (USF), Tampa.