Turn on the television or radio, pick up a newspaper or magazine, and you're likely to find something on the subject of taxes. This debate is especially prominent as it relates to the federal deficit and debt. On one side is the argument that if you cut taxes government revenue will fall and the debt will expand. Others contend that cutting taxes stimulates the economy which, in turn, leads to an increase in government revenue. Who is correct? To answer this, let's journey back to 1913, the year the modern tax code was enacted.
1913
In 1913, the Sixteenth Amendment was ratified, giving the Federal government the authority to levy an income tax on individuals and businesses. Its design was "progressive" in that the tax rate rises as income rises. This assures that those earning a higher wage will pay a higher percentage. From 1913 to 1915, the highest marginal tax bracket was only 7.0%. This top rate reached 94% in 1945, the final year of WWII.
Framing Today's Debate
The real question today is: "How do changes in income tax rates affect federal receipts?" Clearly there are deductions and credits which also influence the result. But in the final analysis, the percentage that taxpayers pay is the key statistic.
The following graph clearly reveals the answer. The red line represents the top marginal tax bracket while the blue line shows the total amount of Federal government revenue each year. There are two salient points here. First, as the graph illustrates, as tax rates declined, government revenue increased. Second, there is a strong negative correlation between the two. To review, correlation measures the relationship between two sets of data. The scale ranges from negative one to positive one. A correlation of positive one indicates that the two data sets move in concert with each other. A correlation of negative one indicates that as one set of data moves up, or down, the other moves in the opposite direction. Using the data from 1913 through the end of 2011, the correlation between the maximum marginal income tax bracket and total Federal receipts is a negative 0.50. In simple terms, when taxes are cut, Federal revenue has a very strong tendency to rise! And when taxes are raised, government revenue has a strong tendency to fall.
The next time you find yourself engaged in this debate and someone tells you that you that taxes must be raised to pay down the debt, you can refer them to this article. In conclusion, as JFK, Reagan, and George W. Bush understood, reducing taxes has a stimulative effect on economic activity which leads to an increase in government reciepts. You can't argue with history!
Thanks for reading!
See also:
