The mass media does little to analyze income tax policy while repeating misleading charges in circulation for more than a quarter of a century. These same charges are now directed at the Republican Congress and the Bush administration.
What is the truth? The truth lies in understanding some basic concepts.
Tax rates determine the percentage of income owed. However, an increase in tax rates does not mean government revenues will increase. Does anyone believe that an income tax rate of 99 percent would result in an increase of revenue? Of course not! The very question of a 99 percent rate forces us to recognize the effect that income taxes have as incentives and disincentives to work. Likewise, a reduction in income tax rates does not necessarily mean a reduction in revenues. Why? Would you work harder and longer if you could keep 65 percent of your earnings rather than only 30 percent? Most people would answer: “Of course!”
The answer to the last question is a big step in understanding the assumptions of supply side economics. When people are allowed to keep more of their earnings they work harder and smarter to increase their income, and they pay more taxes even though their tax rates have been reduced. These realities are the impetus for the tax rate reductions that occurred in the 1980s and during the present Bush administration. When Ronald Reagan was inaugurated in 1981, the highest marginal personal income tax rate was 70 percent. Today it is 35 percent. (Marginal refers to tax rates that are applied incrementally rather than to all taxable income. For example, in 2005 the highest rate applied only to income over $326,450. This contrasts with the 10 percent rate paid by married couples on the first $14,600 of income.)
The term supply side was coined to contrast with the emphasis on demand which characterized economic theories of John Maynard Keynes and those influenced by his ideas Keynesian thought stressed government’s role through public spending which was supposed to prime the pumps of the economic system. The “stagflation” of the late 1970s stunted the economy with high inflation and rising unemployment as Keynesian economics ran up against a stonewall. The old ideas proved lacking and mortgage rates went as high as 20 percent.
Supply side economics, with its incentives to invest and take risks, was conceived as a way out of the “stagflation.” It worked. The economy and income grew as a result of these incentives and there was a bigger income “pie” for the government to tax and therefore more revenue for the government.
However, income tax rates are just one part of fiscal policy. The other is spending. The government may increase its revenues and the economy may expand, but if increases in spending exceed increases in revenues then budget deficits will occur. This is what occurred during the Reagan years as the nation rebuilt its defense establishment. However, the deficits of the Reagan administration and the deficits of the present Bush administration cannot he explained by income tax rate reductions. The wealthy continue to not only pay more taxes in actual dollars but as a proportion of all personal income tax collected.
Look at the facts.
In 1981 when Congress passed the KempRoth tax bill at the urging of President Reagan, the top 5 percent of taxpayers paid 35 percent of the total personal income taxes. By calendar year 1985 that share had risen to over 40 percent. By the turn of the century that share had increased to more than 50 percent. In calendar year 2003 the top 5 percent of taxpayers paid more than 54 percent of total personal income tax. (Data for calendar year 2003 are the most recent at the time of this writing and the calculations are based on all income excluding social security.)
How about the working man or mom? How did they fare under the ongoing revisions of the tax code pushed by Republicans in Congress and the White House? In calendar year 2003 the bottom 50 percent of all income tax payers paid less than 4 percent of the total income taxes paid that year. That is no typographical error — less than 4 percent is the correct figure
Another interesting datum: The top 10 percent of taxpayers in calendar year 2003 paid 66 percent of the total personal income taxes — that is almost two-thirds of the total.
So yes, there is a grain of truth in the liberal harangue against tax cuts for the rich. Since the very wealthy pay a greatly disproportionate share of the income taxes, any meaningful income tax rate reduction will affect them in greater degree. But the result of these rate reductions continues to be higher tax payments by the rich — the same rich whose success in the marketplace inflames the liberals.