Like Will, I wished I had had more time to spend on the Big Con book club at TPM Cafe, but last week was busy, and this week continues so.
Like Will, I had problems with this passage:
From 1947 to 1973, the U.S. economy grew at a rate of nearly 4 percent a year — a massive boom, fueling growth in living standards across the board. During most of that period, from 1947 until 1964, the highest tax rate was 91 percent. For the rest of the time, it was still a hefty 70 percent. Yet the economy flourished anyway.None of this is to say that those high tax rates caused the postwar boom. On the contrary, the economy probably expanded, despite, rather than because of those high rates. Almost no contemporary economist would endorse jacking up rates that high again. But the point is that, whatever the negative effect such high tax rates have, it’s relatively minor. [emphasis mine]
My response to this was: huh? Two things Chait either does not understand or takes pains to ignore: (1) the relevant counterfactual and (2) the compounding nature of economic growth. He concedes that these astronomical rates put a brake on growth — and for about a third of a century (i.e., the ‘47 -’73 boom plus the following downturn until the ‘8os cuts.) So what would the growth rate have been with much lower tax rates? I don’t know. Depends on how much lower, obviously. But, other things equal, higher. (Anyone know of a rigorous estimate?) And Chait agrees.
My problem is a little different, though: the effect was probably not that big. And the reason it wasn't that big, is not that marginal tax rates don't matter, but that almost no one paid those marginal tax rates.
In 1951, the year that rate was enacted, the 91% tax rate kicked in at $400,000 for a married couple filing jointly (Moreover, due to statutory adjustments, its effective limit was about 87%, but that's a quibble). In today's dollars, that's about $3.2 million. By 1963, it's last year, inflation had eroded it to perhaps $2.7 million. That's the kind of income that puts you somewhere over the line for the top 0.05% of households in the United States. In other words, we're discussing something under 50,000 tax returns.
Moreover, even those who had very large incomes didn't pay anything like a 91% effective marginal rate, because deductions were much easier to come by before the 1986 tax reform. That's how we got the AMT; people used to find it relatively easy to structure their income to evade tax. Too, corporations found ways to give income to their employees in tax-advantaged forms, such as lavish expense accounts. So that rate impacted very, very few people, most of whom, I grant, would probably have kept working anyway just because they liked being the president of GM. But Fortune 500 CEO's are not where we look for the meat of the action on the incentive effects of tax changes; we look, rather to occupations that are remunerative but not particularly glamorous, like owning a plumbing supply factory or being a proctologist. And those people did not come near being impacted by such high tax rates.
Today, on the other hand, our top rate kicks in at about $300,000 of household income--the salary of two law firm associates. I'm not asking you to feel sorry for them, as I certainly don't; but the vast majority of law-firm associates I know are actively looking for jobs that will require less work. Raising the tax on their extra income by ten percentage points might well make that decision much easier.
(Which is not to say that we shouldn't do it; only that comparing this situation to 1951 is a little loonie.)
Did you have problems with that passage when you read the book, or problems with it after Will birddogged it for you?
Absolutely right. I was a tax lawyer in the early 1970s. I had exactly one client who paid the top marginal rate, a guy so rich he couldn't be bothered to do anything about it. Everybody else was in one or another sort of tax shelter. Back then, economists used to estimate the revenue loss from dropping the top rates drastically, and it was always trivial, because nobody who didn't want to pay at those rates had to.
If the top rate was 91% it would seem that people would have a much higher incentive to start their own business vs. becomes an doctor, lawyer, consultant, etc.
If I start a plumbing supply factory at 25 and pay mayself a modest salary and pour everything back into the business, I can sell it for 2,000,000 when I'm 50 and only pay the 1951 capital gains tax rate of 25%.
However, if I'm a lawyer and I make partner and make that same 2,000,000 over those same 25 years the government is going to take a lot more of my money - back in 1951.
Also, there is a huge incentive to put in extra hours at the plumbing company when I know I'm building my business and will get to keep 75% of what I build. For the lawyer, when you hit the 70% bracket it doesn't really make any sense to spend more time in the office.
I think high rates would be far more destructive now as we have far more knowlege workers and less of our economy is based on rust belt industries like plumbing supplies.
"And the reason it wasn't that big, is not that marginal tax rates don't matter, but that almost no one paid those marginal tax rates."
Which then begs the question: if the effect of those "astronomical" marginal rates was "not that big," then why the continuous kvetching about the progressive income tax being a drag on productivity and growth? Are we making a mountain out of a molehill, here?
LiberalRob, if the astronomical tax rate affects people's economic decisions, then it will probably reduce growth, even if no one pays it. If, because of taxes, everyone invests in dental partnerships or municipal bonds instead of in Microsoft, or employees prefer being paid in perks like company cars to being paid cash, then you will see growth suffer.
Which then begs the question: if the effect of those "astronomical" marginal rates was "not that big," then why the continuous kvetching about the progressive income tax being a drag on productivity and growth?
Because a properly progressive income tax must actually collect at the upper tiers, and from a majority of all income earners falling within those tiers. Doing that pushes all the right theoretical buttons for clamping down on growth, which IS a concern if we're going to look at the real-world plausible outcomes, instead of resorting to examples from the past when nominal onditions seem to counterpoint, but actual conditions were much different.
"Doing that pushes all the right theoretical buttons for clamping down on growth..."
But the effect was "not that big." Are you disagreeing with Megan?
I really don't see it. All it seems like is we are arguing over whether the same money goes into government spending (which theoretically helps the entire nation) or stays in the (wealthy) wage-earner's pocket (which helps the wealthy wage-earner). Which I guess is the usual fiscal liberal vs. fiscal conservative argument, but still. If the effect on overall growth is "not that big" then why the big deal.
rob...well yes, that is part of the argument. You believe the govt makes better choices than you could, or that collectively it makes better choices, on the whole, than we do individually.
Not many sympathetic ears on this blog for that talk though of course many, like me, are all over the map.
The fact remains though that allowing me to put more of my money to productive use will 'grow' the economy more than transferring it directly to poor people. Using the most general example. But you have no pity for those making more than $300k/year, I presume, so who cares?
If the top rate were actually 90%, don't you think there'd be other ways (as Megan points out) that companies would find to actually compensate their most productive employees that would not subject them to this rate, but still entice them to continue working? Can there be any doubt that revenues would go down?
liberalrob wrote: But the effect was "not that big." Are you disagreeing with Megan?
Perhaps I wasn't clear, although I think Megan was. The reason growth wasn't quenched was because this highly-progressive tax rate...wasn't. The steep tiers, peaking at a nominal 91%, generally weren't collecting from the income earners they were targeting, reducing the nominal rates to a mostly-fictional aesthetic.
Hence, the cited example does not tell us that a strong growth economy can coexist with a highly progressive tax rate; and the reason some of us are concerned about highly progressive tax rates is that somebody might actually implement a real one, only to rediscover the doctrine of trade-offs.
"You believe the govt makes better choices than you could, or that collectively it makes better choices, on the whole, than we do individually."
I don't know if I'd go that far ("better" being a relative term), but at least the government theoretically is trying to provide services to the entire nation, whereas my choices only directly affect me and a small circle around me.
"The fact remains though that allowing me to put more of my money to productive use will 'grow' the economy more than transferring it directly to poor people."
Aren't poor people more likely to spend their money back into the economy than rich people who have more than they can spend? Think "Brewster's Millions" here; beyond a certain point it's HARD to spend a lot of money even if you try.
"...don't you think there'd be other ways (as Megan points out) that companies would find to actually compensate their most productive employees that would not subject them to this rate, but still entice them to continue working? Can there be any doubt that revenues would go down?"
But those "other ways" still constitute economic activity, don't they? Whether I get a cash bonus or a car at the end of the year, it's still something of value (and I think it takes more work- and more workers- to build me a car than it does to print up a stack of 20's). I understood Megan to be saying that the relationship between marginal tax rates and economic growth was a weak one at best. Yes revenues would go down if less taxes were paid, but revenues!=growth, right?
I know you want to argue that lower taxes stimulate growth due to more capital being in the pockets of entrepreneurs to invest. But I look at government spending as stimulating growth as well, and (again I'm not an economist) it seems to me that we pretty much have a closed system once you get past the individual worker putting in his time in exchange for money; once the money is created and given value the path it takes through the system is pretty much zero-sum (less money here means more money there). At that point, given the choice between entrepreneurs affecting the small circle of people they can invest in versus the government providing services to the entire nation, I have to lean toward the government having the money. That's part of why I call myself a liberal.
I admit I could be wrong. This just feels right to me.
you all are ignoring that the US had very little competition during this period, all other real economies having been destroyed by war. so tax rates may not have affected growth the way they would if we had competition.
for those who think that marginal tax rates don't affect how much people want to work, whether (to use jane's example) lawyers will works at law firms or take that gov't or public interest job, you obviously haven't been faced with that choice or know many people who have.
put another way, it's not just about who gets the money (gov't or individual), but whether the money is ever created.
LR: thanks for admitting your unfamiliarity with the issue.
The major concern with anyone who has actually focused on this is that there are productive and non-productive things that can be done. There are also ranges of productivity - Return on Investment and other financial analyses are focused on determining what things are most useful to do. New Deal works projects were exceptionally unproductive, but they were attempts to pick up slack in the economy (let's leave off the arguments about the propriety of FDR's work, just look at what it was supposed to do).
While you can use the government to keep the nominal economy going at a certain level, the real economy is going to grow less quickly or decline when resources are thrown into less productive areas. Oil rich countries provide excellent examples of how you can seem to have an economy but it all being a charade where no value is actually created. The USSR was famous for making minerals less valuable by making cars and consumer goods out of them (or, well, trying to - don't know if Lada really counts as a car).
Higher tax rates make tax advantaged investments much more valuable, even if they suck. Municipal bonds right now are excellent examples of crappy investments made attractive by idiotic tax policies. Every dollar that goes to an accountant or tax-lawyer is a dollar that is wasted. It could have gone into some productivity enhancing venture, capital goods, something. Same as government employees - total deadweight loss. Police and the DoD only destroy value as well - this is economic analysis rather than pure partisanship (though you can see how it leads to anti-government feelings). Police and DoD act like insurance, security systems, and and sprinklers - they are most likely wasted but they serve to reduce risk and mitigate loss.
All of this is exceptionally basic economics. Go back to uni and take micro and macro until you've grasped the idea. The whole point of the economy is that it isn't zero-sum but instead positive-sum, but that government spending is zero-sum at best. Instead of building palaces our government destroys value by creating social programs for the greater glory of a Kennedy, but it has the same effect.
"Oil rich countries provide excellent examples of how you can seem to have an economy but it all being a charade where no value is actually created."
Except the poor have hospitals to go to. I know that doesn't strike rightists as valuable, but ultimately, that's what this discussion is about: not economics, but values.
"Every dollar that goes to an accountant or tax-lawyer is a dollar that is wasted."
Accountants and lawyers don't spend money?
"Go back to uni"
Having barely escaped with my life the last time, I'm extremely loath to go back there.
I'm still grumpy because of the Reagan-Bush deduction disappearing act. I LIKED my deductions, the sales tax, the interest rates paid out, all of those little things that made my heart go pitter patter when I was able to wring out another 42$ from the tax paid.
It was infuriating when the tax rates started climbing back up a couple of years later. Especially when the IRS started making rulings that put more kinds of things into the 'Income' bracket so that it could be taxed, but wasn't taxed earlier.
A flat tax would be good, but how to set the level, now there's the rub.
I just want to applaud you in joining those of us who believe you don't actually have to read books to review them.
http://jonswift.blogspot.com/2006/11/jon-swifts-complete-amazon-reviews.html
"...once the money is created and given value the path it takes through the system is pretty much zero-sum (less money here means more money there)."
Creating money isn't the issue. We can print as much or as little of it as we care to. Its wealth - useful stuff and services - that matter.
Entrepreneurs create wealth (or go broke trying). If you take money away from them (or reduce their incentive to take risks), they will create less wealth.
Governments sometimes create wealth -- building bridges, rule of law etc. And governments sometimes just move money around (at gun point).
"...given the choice between entrepreneurs affecting the small circle of people they can invest in versus the government providing services to the entire nation..."
Huh? Think of everything in your life, which you value. How many of those things are available to all of us because someone created those things with the expectation of making a profit and traded them to you in a mutually beneficial exchange?
The company that runs the local supermarket benefits more than just a small circle of investors. Entrepreneurs create the vast majority of stuff we value (wealth) in society.
I'm all for discussing marginal rates and when they have a significant impact on incentives, but let's not imagine that significantly reducing entrepreneurs incentives to risk capital wouldn't be a bad thing.
liberalrob:
"This just feels right to me." There you have it, folks.
Do us all a favor and go actually read Von Mises and Schumpeter and Hayek and Friedman.
Then read them again so the stuff will sink in for sure.
PLEASE. You are hurting my head with your comments.
Your head will hurt more if I do that, then come back and say they are all full of it (though from Wikipedia's summary Schumpeter looks pretty decent).
If you don't want to deal with people who haven't read every last monograph by some obscure Austrian economist, a blog is not the place you want to be. We're not all going to be Econ majors. I myself am a PoliSci BA who has fallen into a career as a web/db integration programmer. Yet I vote and have opinions on things, uneducated as you might feel they are. Either convince me yourself or ignore me.