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Tax Cuts and the Rich
Get Adobe ReaderBRIEF ANALYSIS
No. 158
For immediate release:
Wednesday, April 12, 1995
Tax Cuts and the Rich
That does not mean that changes in federal tax policy have no effect. From the harshness of tax policy debates in recent years, one might suppose that the tax burden had been shifted from the rich to the poor. In fact, major tax cuts in the 1980s did just the opposite. They shifted an increasing share of tax payments to the wealthiest taxpayers.
Before the Reagan Tax Cuts: Bracket Creep.
From 1976 to 1981, federal receipts rose from 17.7 percent to 20.2 percent of gross domestic product. Such a sharp increase in federal revenues over such a short period of time is unprecedented in peacetime. Its principal cause was bracket creep, which results when inflation increases nominal incomes and pushes people into higher tax brackets even though their real incomes have not risen. It was estimated at the time that federal revenues increased 1.6 times the inflation rate. Thus the faster the inflation, the more revenue the government received. For the most part, bracket creep tends to shift the burden of taxation from higher- to lower-income families. Since the highest-income families are already in the highest tax bracket, they can't be pushed into a higher bracket by the effects of inflation alone. This of course is not true of middle- and lower-income families.
Progressive Effects of Reducing the Highest Tax Rates.
The Reagan-era tax cuts were based on the premise that the government should never take more than 50 percent of an additional dollar of anyone's income, no matter how rich that person might be. Indexing was adopted to prevent bracket creep. Reagan also pushed for repeal of many tax credits, exemptions and loopholes in the tax code in order to reduce rates further. By the time he left office, the top tax rate was just 28 percent - its lowest level since the 1920s.
Evidence continues to mount that the lower rates actually increased the amount and share of taxes paid by the rich. Figure I shows that the share of total federal income taxes paid by the top 10 percent of taxpayers, ranked by adjusted gross income, rose from just under 50 percent in 1980 to more than 57 percent by 1988. Thus during a period in which their marginal tax rate fell by 60 percent, the wealthy paid almost 19 percent more in federal taxes.
The reason was that the wealthy increased their taxable income by much more than the cut in rates. Instead of clipping coupons on government bonds, some invested in venture capital funds; instead of buying tax-free municipal bonds, they bought stocks; instead of investing in exotic tax shelters, they started new businesses; instead of taking their income in the form of vacations or tax-free benefits, they asked for higher cash wages; and instead of spending time figuring out how to limit their tax liability, they concentrated on increasing their wealth. In many high-income families, a spouse who had not been working outside the home was enticed into the workforce by the prospect of not paying 70 cents of every dollar earned in taxes.
Thus, as Figure II shows, the number of taxpayers reporting an income of more than $200,000 (in constant 1977 dollars) dramatically increased following the Reagan tax cuts, after remaining stable for many years. As evidence that the tax cuts made the difference, after the 1990 tax increase raised the top rate, the number of taxpayers reporting an income of more than $200,000 dropped significantly.
The Debate Over Tax Fairness.
Robert S. McIntyre of Citizens for Tax Justice recently said, "Tax cuts for the very richest people and interest on the debt that was built up to pay for those cuts can explain the entire increase in the federal deficit over the past 15 years." Yet as we have seen, nothing could be further from the truth. The tax burden for the country as a whole did not go down, and the lowering of tax rates caused the share paid by the highest-income families to go up.
Far from increasing the deficit, the Reagan tax cuts reduced it. Had tax rates not been cut, rich people would have had no reason to change their behavior. Their incomes and their share of tax payments would not have risen. If the wealthiest taxpayers' percentage of federal income taxes had remained constant through the 1980s, by 1988 the group would have paid the federal government $32.2 billion less than it actually did. The most affluent Americans have great flexibility in how they receive income and whether they work less or not at all. High tax rates on the wealthy may make the promoters of economic class warfare feel good, but they do not raise revenue for the federal government
This Brief Analysis was prepared by NCPA Senior Fellow Bruce Bartlett.
Note: Nothing written here should be construed as necessarily reflecting the views of the National Center for Policy Analysis or as an attempt to aid or hinder the passage of any legislation.