The Truth (About Taxes), Justice and the American Way

With all the noise coming out of Washington recently over whether or not we should raise
marginal tax rates on the wealthiest Americans, I became curious to know whether the claims
being made by Paul Ryan and the Republicans were accurate. After all, I am the small business
owner, that engine of job growth that is theoretically going to stop hiring and investing if
marginal tax rates go up by 4.6%. To be honest with you, when I heard this I felt pretty stupid.
I had never even thought about the top marginal tax rate when deciding whether to hire more
employees. Naively, the only thing I looked at was whether we needed the additional people to
operate the business.

So I decided to do some research… on the Internet. I am of part of that lost generation that still
thinks the Internet is cool. I never cease to be amazed by what I can look up on line. My kids
on the other hand think of the Internet as just another appliance, like the TV or the
refrigerator. In any event, I entered “top marginal tax rates” into Google and up came a
plethora of sites. The best one was “TruthAndPolitics.org.” They provided a table of both the
top marginal tax rate year-by-year and the income level where the top rate kicked in. I have to
admit, I was fascinated by what I discovered. First, as many of you probably know, there was
no income tax in this country before 1913. What you probably don’t know was that when the
Federal Government first established an income tax, the top rate was only 7% and applied only
to income over $500,000 – in 1913 dollars. In today’s dollars that would be $11.4 million.
Clearly income tax was not something the man in the street needed to concern himself with in
1913.

As it turned out, however, income tax was like heroin – once you start you keep needing more.
By 1918 the top rate had jumped to 77% but applied only to people making more than $1.0
million a year ($16 million in 2011 dollars). Then in 1922 the rates started to fall getting as low
as 25% by 1925 where they essentially stayed until 1932 when they were raised to 63%. It is
interesting to note that the lowest rates in our history preceded the greatest economic
depression of all time. Rates were raised again in 1936 to 79% and again in 1942 to 88%. Then
from 1942 to 1963, 21 years, the top rate stayed between 88% and 94%. The top tax bracket,
however, from 1948 to 1964 was $400,000. While this was quite a bit lower than the $1.0
million of 1918, it was still between $2.9 million and $3.75 million in today’s dollars. In 1964
the top rate was lowered to 77% and by 1971 had fallen to 70% where it stayed until Ronald
Reagan reduced the top rate to 50% in 1982. Then in 1987, things really started to get fun as
Ronald Reagan and the George Bush (the first) lowered the top rate to 28%. This turned out to
be too much fun, however, and George (“Read my lips”) Bush was forced to raise rate back up
to 31%, which as we all know, cost him the election. This set the stage for Bill Clinton, who
raised the top rate to 39.6% where it stayed for all eight years of his presidency. Then in 2003
that self proclaimed “decider” George Bush (number two) lowered the top rate to 35% to spur
the economy. Go get ‘em Tex. And that is where we are today.

So what effect did these vastly different top marginal rates have on job creation and economic
growth? Once again, back to the Internet (it is so cool!). I looked up “GDP by year” and was
able to find not only the actual GDP numbers but also the federal deficit as a percentage of GDP
from 1900 through today. Job growth numbers were a little harder to find but I came across a
site that had taken the raw data from the Bureau of Labor Statistics and provided job growth
numbers by presidential term starting with Harding / Coolidge in 1921. This actually worked
quite well for my purposes as it smoothed out the more volatile annual numbers.

Here is what I discovered. First, since the inception of an individual income tax, the average top
marginal rate has been 58.7%. It makes you wonder why some of our esteemed Senators and
Representatives start to foam at the mouth at the thought of a 39.6% top rate. That is still
19.1% below the historical average. Second, over the last 110 years, GDP growth has averaged
6.4%. Third, since 1921 when the Federal government started tracking “total nonfarm payroll
employment” numbers, annual job growth has averaged 1.8%. Finally, while over the last
decade we have come to accept federal budget deficits as an inevitable fact of life, it has not
always been so. In fact, the federal government has run surpluses in 24 of the last 97 years
(since the income tax was instituted). Moreover, while we ran large deficits during WWII
averaging 19.1% of GDP (a simply staggering number), once the war was over the country
embraced fiscal responsibility, running surpluses in 7 of the next 11 years. In fact, from the end
of WWII through 1979, our federal deficit as a percentage of GDP averaged only 0.6% and we
actually ran surpluses in 9 of the 33 years. Since then our average deficit as a percentage of
GDP has been running at 3.0%. There was a bright spot during the Clinton years where we ran
sizable surpluses for 4 years in a row. Since then, however, things have gone from bad to worse.

Deficit as a % of GDP
30.00

20.00

10.00

0.00
1913

1922

1931

1940

1949

1958

1967

1976

1985

1994

2003
1916
1919

1925
1928

1934
1937

1943
1946

1952
1955

1961
1964

1970
1973

1979
1982

1988
1991

1997
2000

2006
2009

(10.00)

Armed with all of this data, I then wanted to see what happened to job growth and GDP growth
in both high top marginal tax rate periods and low top marginal tax rate periods. To do this I
looked at those years when the top rate was 70% or above (48 out of the last 97 years) and
those years when the top marginal tax rate was 40% or below (37 out of the last 97 years).
Together, these two periods accounted for 88% of the time since the imposition of a federal
income tax in 1913. It seems that the pendulum swings back and forth, rarely stopping in the
middle. The results were surprising to say the least. In those years where the top tax rate was
70% or above, GDP growth averaged 9.0% and job growth averaged 2.6%. Conversely, in those
years where the tax rate was 40% or below, GDP growth was an anemic 4.4% and job growth
was… well actually there was no job growth. The average for the 37 years where top tax rates
were the lowest, job growth averaged zero!

I am not statistician, but I think that based on the historical data, if there is any correlation at all
between lower top marginal tax rates and economic growth, the correlation is negative. As a
result, politicians need to stop fear mongering and tell the truth. Raising the top marginal tax
rates will not kill job growth. Higher oil prices, the fallout from the tsunami in Japan and a
moribund housing market may kill job growth – but not a higher marginal tax rate.

So based on this research what do I think we should do? Raise the top marginal tax rate of
course. In the immortal words of that famed sage and philosopher John “Blutto” Blutarsky –
“We need the dues”. Moreover, we should raise the top marginal tax rate above the 39.6%
currently being discussed in Washington. At the same time, however, we should add more
brackets, substantially raising the income level where the top tax bracket kicks in. I am no class
warrior, however, as Willie Sutton famously said when asked why he robbed banks – “That’s
where the money is.” Raising taxes on individuals earning more than $5.0, million, $10 million
or even $25 million a year may not in and of itself solve the problem, but it would surely help.
Moreover, it would start to chip away at a growing income inequality problem which is a going
to become an increasingly important issue for America in the years to come. For those who
would say that raising the top rate would destroy the innovation and creativity that has come
to define America, my only response is that America was a pretty great country for the 50 years
from 1936 through 1986 when the top marginal tax rate was between 50% and 94%. We
would do well to regain a little of that greatness.

Bryan S. Ganz
Scudder Bay Capital
Residential Mortgage Solutions
300 Bear Hill Rd
Waltham, MA, USA 02451
Tel: 617-284-1400 Ext. 201
Fax: 781-622-3727
Email: bganz@scudderbay.com