Buffett May Be Right, but the Top Tax Rate is Wrong
Printer-friendly versionPDF version
a a
Type Size: Small
The Fiscal Times
August 19, 2011

On Monday, financier Warren Buffett ignited a tax debate by recommending a tax increase on the super-rich. The reaction by some Republicans and others has been that if Mr. Buffett wants to pay more, he should simply write a check to the Treasury Department and send it to Washington. While such a sound-bite response may go over well on Fox News, it is a completely unserious response to the point he made.

It's axiomatic among Republicans that taxes on the rich are the single most important factor determining economic growth. If that were true, then the period from 1988 to 1990, when the top rate was just 28 percent, should have been the most prosperous in recent American history. During that time we had the lowest top rate since 1931. But although 1988 started out okay with a real GDP growth rate of 4.1 percent, it fell to 3.6 percent in 1989 and just 1.9 percent in 1990.

Conversely, the period from 1993 to 2000, when the top rate rose from 31 percent to 39.6 percent, should have been a period of dismal growth. But in fact, that period was the most prosperous in recent American history. Real GDP growth averaged 3.9 percent per year – more than 50 percent above the average postwar growth rate.

Then there should have been a burst of even faster growth when the top rate was reduced in the 2000s to 35 percent – a rate that is still in effect. But during that period, real GDP growth has averaged just 1.8 percent – 30 percent below the average postwar rate. 

So where is the data supporting the argument that taxes on the rich are the sine qua non of growth? I don’t see it. On the contrary, the data from the last several decades would in fact support the opposite conclusion – that higher tax rates on the wealthy stimulate growth. It is worth remembering that throughout most of Ronald Reagan’s presidency the top rate was 50 percent, and Republicans believe his economic policies are the gold standard that we should try to emulate in every way possible.

"The top statutory rate now
applies to a relative modest amount
of income....The threshold in 1913
was actually $11 million per year."

One reason why Republicans may grossly overestimate the economic significance of the top income tax rate is because over time the income level at which the top rate takes effect has fallen sharply. It now applies to a relative modest amount of income. In the past, one needed to be very wealthy indeed before paying $1 of income taxes at the top statutory rate.

When the income tax was established in 1913, the top rate didn’t begin until someone made at least $500,000 – that’s more than the threshold for the top rate today, which is $374,000. But of course there has been a vast amount of inflation since 1913. In 2010 dollars, the threshold in 1913 was actually $11 million per year. Obviously, very, very few people were affected by the top rate at that time.

The history of the top rate is that it has normally applied only to those with very large incomes by any standard. During the 1930s, Franklin D. Roosevelt raised the top rate to 79 percent – a policy universally condemned by right wingers ever since. What they never mention is that he also sharply raised the income threshold at which the top rate applied.

Under Herbert Hoover, the top rate began at an income of just $100,000, but under Roosevelt the threshold increased to $5 million per year – almost $80 million in today’s dollars. It is said that when the top rate was increased in 1936, only one person in the United States – John D. Rockefeller – was affected.

During World War II, the threshold for the top rate fell to just $200,000 and has never gotten much above it since. When Reagan took office, the top rate began at an income of $215,000. And although he reduced the top rate, few people realize that he also lowered the income threshold for it to just $85,600, which wasn’t very much income to be considered rich even in 1992. In 2010 dollars, that was less than $200,000 per year.

It may be true that any household
with an income of $370,000 is very
well to do. But it’s not rich by any
reasonable definition of the term.

Furthermore, when Reagan reduced the top rate to 28 percent in the Tax Reform Act of 1986, the income threshold was further reduced to just $30,000 – a little over $50,000 in today’s dollars. However, when Bill Clinton raised the top rate in 1993, he also dramatically raised the income threshold from $86,000 to $250,000 – $377,000 today.

While George W. Bush lowered the top rate, he did nothing to change the threshold income level at which it became effective. Since Clinton’s time, the only change in the top rate’s income threshold has been indexation for inflation, which has kept it around $370,000 in 2010 dollars.

It may be true, as those on the left like to point out, that any household with an income of $370,000 is very well to do. But it’s not rich by any reasonable definition of the term. Therefore, average people who may aspire to make that much some day are reasonably concerned when there is talk of raising the top rate.

The obvious compromise is for those like Mr. Buffett who believe that the top rate should be increased, for both financial and distributional reasons, to make clear that they are talking only about people who really are rich. The top rate ought to stay at 35 percent for those in the $370,000 to $1 million income range. But those making $1 million can easily afford to pay 40 percent, which was the top rate in the 1990s, and those making $10 million annually could pay 50 percent, the top rate under the Reagan administration.

Given our budgetary situation, it is irresponsible to keep higher revenues completely off the table, as Republicans insist. And their dogmatic belief that low taxes on the rich are the key to growth is transparent nonsense. But it’s reasonable for the modestly well to do to fear being treated like millionaires when there is talk of raising taxes on the rich. Higher tax rates on the rich should apply only to those who really are rich.

Bruce Bartlett’s columns focus on the intersection of politics and economics. The author of seven books, he worked in government for many years and was senior policy analyst in the Reagan White House.